

















THE APPLIED THEORY 

OF 

ACCOUNTS 


BY 

PAUL-JOSEPH ESQUERRE, B.esL. (France), C.P.A. 

Head of Post-Graduate School of Accountancy; Member, 
American Institute of Accountants; Member, New York 
State Society of Certified Public Accountants; Author of 
“ Practical Accounting Problems ” 



Fourteenth Printing 


NEW YORK 

THE RONALD PRESS COMPANY 


1923 








Copyright, 1914, 

BY 

The Ronald Press Company 


"5 ^ \ 

P' W'v ^ *Jt_ 



PREFACE 


Just before the dawn of the French Revolution, there 
was, at the Military College of Brienne, a young student 
whom his classmates called the “Visionary.” Never mix¬ 
ing in their noisy pastimes, he would spend hour after 
hour in his room, drilling tin soldiers on a large table. 
Dirt, sand, and pieces of glass became hills, fields, and 
rivers; twigs picked up in the playground were his cannon, 
while leaves, planted straight in the sand, were to him as 
forests. His tin soldiers were led or blue; some were 
mounted, and others, on foot. Night after night, while 
his comrades slept, the “Visionary” would pitch the blue 
soldiers against the red; the cannon would roar, and in¬ 
fantry and cavalry, pushed by his thin fingers, would fall 
dead on the battle-field. 

A few years later, when the English fleet blockaded the 
port of Toulon, and threatened the existence of the Revo¬ 
lutionary Government, the visionary youth, now an officer 
in the army of France, pitched his “theoretical” knowl¬ 
edge against the “practical” knowledge of men who had 
grown gray under the soldier’s uniform, and to their 
astonishment, and to the dismay of the invader, he dis¬ 
covered the one strategic point which rendered a battery 
of artillery so effective as to compel the immediate retire¬ 
ment of the enemy’s fleet. 

The young officer of artillery knew nothing of war¬ 
fare but its theory; yet he succeeded where practical 
strategists had stood in impotent rage. Later, when he 

became Emperor of the French, it was said of him that his 

• • • 
in 


IV 


PREFACE 


unequalled knowledge of the theory of artillery opera¬ 
tions won his battles before they were fought. 

It is the purpose of this book to instruct the student 
in the principles of accounting, as the practice drills with 
his tin soldiers instructed Napoleon the First in the prin¬ 
ciples of war. May the conscientious presentation of these 
principles of accounts teach the young accountant how to 
win the bloodless battles of his chosen profession. 

Accounting is essentially a militant science; if it re¬ 
mains passive, it must die. To live, it must war inces¬ 
santly against carelessness, ignorance, inefficiency, evil- 
disposed cleverness, and, possibly, against dishonesty. 
Having won, it must rebuild where it has destroyed; but 
the new structure must be such that it can never again be 
successfully assailed. 

The accountant is a judge to whom appeals are made 
by the employer against the employee; by the “cestui que 
trust” against the trustee; by the stockholder against the 
director; by the director against his associates or against 
the corporate officers or agents; by the government 
against violators of fiscal laws; by the trader, the manu¬ 
facturer, and the financier, against the conclusions to be 
drawn from their own accounts. 

He is also an adviser who must derive from the 
arithmetical results of books of account, often purposely 
confused, facts which will enable him to pass judgment 
upon financial conditions, to guide the judgment of 
others, to suggest remedies, and to devise means of safe¬ 
guarding the interests of all parties, whether clients or an¬ 
tagonists. He must be capable of refuting conclusively 
all assertions which are mere speculation based on sup¬ 
posed or assumed facts which cannot stand the test of 
accounting analysis; he must be able to defend his ground 
by submitting proofs so fundamentally correct and so 
conclusive that they cannot be challenged; he must be so 


PREFACE 


v 


familiar with the anatomy of accounts that the mere men¬ 
tion of a financial transaction will present to his mind a 
diagram of the position which the facts to be recorded 
will occupy in the books, and of the effect which they 
will have upon facts previously recorded; he must be 
able to perceive at once the accounting principle in¬ 
volved, and so to apply it as to compel figures to reveal 
that which they are prone to conceal from the uninitiated. 

If it is true that no one can be a great detective who 
does not know the psychology of the human heart, and 
that a recruit cannot become an efficient gunner until he 
has been taught the theory of ballistic curves, it must be 
true that no one can become an accountant until he has 
learned the theory of accounts. If one is not so equipped, 
he may indeed make his way towards practical account¬ 
ing truth by luck, by intuition, or by plucky determina¬ 
tion, but, before he has reached this goal, he has con¬ 
sumed his energy, exhausted the patience of his clients, 
and too often failed to furnish valuable information at the 
opportune moment. 

The theory of accounts has been evolved from the 
study of economic and financial conditions, from the de¬ 
velopment of commercial methods, from careful analysis 
of the results attained in industries old and new, from the 
application of the principles expressed by judicial de¬ 
cisions in litigation brought about through business rela¬ 
tions, from the doctrines of the law merchant, of the 
common law, and of modern statutes. It is the out¬ 
growth of centuries; and while its principles are immut¬ 
able, they are, at the same time, susceptible of different 
methods of application, which though apparently irrecon¬ 
cilable among themselves, are worthy of consideration on 
their individual merits. 

When about to pass judgment upon the actions of 
individuals or of nations, we are careful to inquire into 


VI 


PREFACE 


the motives which actuated them; and although we may 
not be in sympathy with the methods employed, we do 
not condemn them provided they were adequate to the 
purpose in hand. But when we come to accounting, we 
are naturally arbitrary; the purpose is forgotten, and the 
omy question at issue seems to be the nature of the means 
employed. And yet, the question of adequacy is as vital 
to accounting as it is to all the undertakings of man¬ 
kind. 

The purpose of the baker of the rural districts of 
southern Europe, who in common with the majority of 
his customers is barely able to read and write, is better 
served by the sticks on which he notches his sales, than 
it would be by the most handsomely ruled ledger and 
cash book. Similarly, as the purpose of the small trader 
of all lands is to keep accounts with his customers and 
creditors, he need not trouble himself with what has been 
termed “the only scientific system of keeping accounts” 
(double entry), since single entry, much abused as it may 
be, is able to tell him all that he wishes to know, and is 
much better adapted to his mental equipment. If the 
merchandise account of a trader reveals the information 
of which he is in need, why should he heed the indignant 
protests of philosophers of accounting who tell him that 
there is really no such thing as a merchandise account, 
and that the use of complex accounts will rob him of the 
fruit of his industry, by hiding from him the business 
truth? And if the purpose of the modest manufacturer of 
a staple product, the market price of which is as well 
settled as the demand therefor, is to be as fairly successful 
as the conditions of his particular industry will permit, 
why should he be made to sacrifice a good part of his 
income, in order that he may know through the use of 
“production factors” or otherwise, the cost of every atom 
of the product which he manufactures? 


PREFACE 


• • 
Vll 

It has been asserted repeatedly that it is impossible to 
bring together ten accountants whose views will har¬ 
monize on any given topic of their profession. This will 
always be true to a greater or less extent, since the 
human mind is not adapted to the acceptance of a single 
standard of truth. But these divergent views will become 
largely harmonized just as soon as it is realized that if a 
student of surgery cannot be trusted with an operation 
until he has mastered the anatomy of the human body, 
the student of accounting cannot be trusted with the 
finances of a business until he has mastered the theory of 
accounts. 

Paul-Joseph Esquerre. 

New York City, 

September i, 1914. 




CONTENTS 


PART I—BUSINESS ORGANIZATION 
Chapter I. The Copartnership 

Preliminary 

Sole Proprietorship 

The Copartnership 

Limited Partnerships 

Nominal Partners 

Articles of Copartnership 

The Accountant’s Duty 

The Partnership a Quasi-Legal Entity 

Acquisition of Partnership Property 

Partners’ Debts 

General Partnership Rules 

Precedence of Claims Against Partnership 

Value of the Good-Will 

Partnership Paper 

Status of Retiring Partners 

Status of Continuing Partners 

Status of Incoming Partners 

Chapter II. The Corporation—Stock Securities 

The Corporation Defined 
Corporations Classified 
Shares, Capital, and- Capital Stock 
Dividends 

Kinds of Stock and Its Issue 
Stock Subscriptions 
Property Acquired by Stock Issue 
Labor or Services as a Consideration 
Stock Issued as a Bonus 
Borrowed Capital—Corporate Bonds 
Classification of Bonds as to Security 

( 1 ) Secured Bonds 

( 2 ) Partly Secured Bonds 

( 3 ) Unsecured Bonds 
Typical Bond Issues 


IX 



X 


CONTENTS 


Chapter III. The Corporation—Organization and Management 

Corporate By-Laws 
The Board of Directors 
Stockholders 
Corporate Officers 

Chapter IV. The Corporate Records 

Statutory Requirements 

(1) Minute Book 

(2) Subscription Ledger 

(3) Stock Certificate Book 

(4) Stock Book or Stock Ledger 

(5) Corporate (or Stock) Journal 

(6) Stock Transfer Book 

PART II—THE GENERAL THEORY AND TECHNIQUE OF 

ACCOUNTS 

Chapter V. Accounting Systems—Single Entry 

The Principles of Single Entry 

Single-Entry Ledger Accounts 

Debits and Credits 

The Effect of Debits and Credits 

Equations of Single-Entry System 

Sources of Gains and Losses Not Shown 

Proprietor’s Account 

Closing the Accounts 

Practicability of System 

Chapter VI. Accounting Systems—Double Entry 

The Purpose of Double Entry 
Principles of Double Entry 
A Balancing System 
Rules for Journalizing 

Profit and Loss Account and Nominal Accounts 
Rules for Double Entry 

Basic Differences Between Single and Double Entry 
Passing from Single Entry to Double Entry 

Chapter VII. Accounting Systems—Triple and Quadruple Entry 

Logismography 

Statmography 


CONTENTS 


xi 


Chapter VIII. The Financial Books—The Journals 

The Journal 
The Sub-Journals 

Purchasing Department—Purchase Journal 

Sales Department—Sales Journal 

Treasurer’s Department—Cash Journal 

Petty Cash Book 

Notes and Bills Journal 

Pay-Roll Journal 

Specially Ruled Journals 

Chapter IX. The Financial Books—The Ledger and Voucher 

Record 

The Structure of the Ledger 
Variations of the Standard Ledger 
Private Ledger 
Voucher Record 

Chapter X. The Technique of Posting 

Functions of the Ledger 
Rules for Posting 

Chapter XI. Controlling Accounts 

General and Subsidiary Ledgers 
Genesis of the Controlling Account 
Theory of the Controlling Account 
Self-Balancing Ledger 

Chapter XII. Classification of Accounts 

General Classification 

(1) Real Accounts 

(2) Nominal Accounts 

(3) Accounts Partially Real and Partially Nominal 
Asset and Liability Classification 

Assets and Asset Accounts 
Liabilities and Liability Accounts 


PART III—THE THEORY OF THE ASSET ACCOUNTS 

Chapter XIII. Cash Account—Petty Cash 

The Theory of the Cash Account 
The Cash Account and the Cash Balance 
A Correct Cash Account 


xn 


CONTENTS 


Nature of Petty Cash 
Maintaining the Imprest Fund 
Theory of the Imprest Fund 
Special Duties of the Petty Cashier 

Chapter XIV. Accounts with Customers 

Entries in Customers’ Accounts 
Trade Discounts 
“Accounts Receivable” 

Chapter XV. Notes and Bills Receivable 

Notes Receivable 
Treatment of Notes Receivable 

Treatment of Contingent Liability on Notes Discounted 
Dishonored Notes 
Bills Receivable 

Chapter XVI. Accounts with Goods 

Merchandise Account of Trading Concerns 
•Analysis of the Merchandise Account 
Subdivisions of the Merchandise Account 
Inventory of Trading Merchandise 
Merchandise Accounts of Manufacturing Concerns 
Inventories of the Merchandise Accounts of Manufacturing 
Concerns 

Inventory of Raw Materials and Sundry Supplies 
Inventory of Goods in Process 
Inventory of Finished Goods 
Inventory When There Is No Cost System 
Apportionment of Overhead Expenses 

(1) Labor Rates 

(2) Machine Rates 

The Problem of Expense Distribution 

Chapter XVII. Consignments—Shipments Inward 

Relations of Consignor and Consignee 
Consignee’s Duties and Liabilities 
The Factor’s Accounts and Accounting 
Books of the Factor 

Books of the Factor—Agency Accounts Kept in General Books 
Books of the Factor—Agency Accounts Kept in Separate Books 
The Recording of Consignments Inward—Occasional Consignee 


CONTENTS 


xm 


The Occasional Consignee Theory- 
First Argument and Method 
Second Argument and Method 

Chapter XVIII. Consignments—Shipments Outward 

Accounting Methods 
First Hypothesis 
Second Hypothesis 
Third Hypothesis 
First Method 
Second Method 

Chapter XIX. Land and Buildings 

Distinction Between “Land” and “Buildings” 

Plant Land 
Investment in Lands 
Buildings 

Capital Expenditures 
Revenue Expenditures 

Chapter XX. Building Equipment, Furniture and Fixtures, De¬ 
livery Equipment, Patterns, Other Equipment 

Realty Fixtures and Personalty Fixtures 
The Law of Fixtures 

Distinction Between Realty and Personalty Fixtures 
Furniture and Fixtures 
Delivery Equipment 
Patterns 

Other General Equipment 

Chapter XXI. Machinery and Tools 

Classification of Machinery and Tools 

Machine and Tool Accounting 

Universal Machines 

Special Machines 

Depreciation 

Shop and Hand Tools 

Chapter XXII. Good-Will, Patents, Trade-Marks, Copyrights, 

Franchises 

Good-Will 

Definition 

Personal Character of Good-Will 
The Good-Will of Corporations 


XIV 


CONTENTS 


Good-Will as an Asset 
Depreciation of Good-Will 
Creation of Good-Will 

Patents 

Nature of Patents 
Treatment of Patents 

Trade-Marks 

Definition 

Copyrights 

Definition 

Copyrights as an Asset 

Franchises 

Definition 

Primary Franchises 
Secondary Franchises 
Charges Against Franchises 

Chapter XXIII. Investments 

Surplus Capital 
Speculative Investments 
Permanent Investments 

(1) Loans Secured by Bonds and Mortgages 

The Mortgage Contract 
Mortgage Interest 

Accounting Procedure and the Mortgage Register 
The Nature of Security 

(2) Loans Secured by Collateral 

(3) Investments in Bonds of Other Companies 

The Interest Account 
Relation of Cost to Income 
Investment Accounting 

(4) Investments in Stocks of Other Companies 

(5) Investments in Real Estate 
Accounting for Real Estate Investments 

Chapter XXIV. Specific Funds, Reserve Funds, and Funded 

Reserves 

Specific Funds 
Reserve Funds 
Funded Reserves 
Sinking Funds 


CONTENTS 


xv 


Chapter XXV. Accrued Income Not Due 

Income from Investments 

The Cash Basis 

The Accrual Basis 

Nature of Dividends 

Record of Earnings on Investments 

Income from Bonds 

Chapter XXVI. Accounts Partially Real and Partially Nominal- 

Deferred Debit Items 

Allocation of Periodical Expenses 

Common Accounts Partially Real and Partially Nominal 
Fire Insurance Premiums 
Advertising Contracts 

Stable Supplies, Stationery and Printing, Advertising Matter 
Clearing Partially Real and Partially Nominal Accounts 
First Method 
Second Method 
Deferred Debit Items 
Organization Expense 


PART IV—THE THEORY OF THE LIABILITY ACCOUNTS 

Chapter XXVII. Capital Stock 

The Share and Its Functions 
Capital Stock as a Liability 
Capital Stock Records 
The Status of Unissued Stock 
Premiums on Capital Stock 
Discount and Premium Accounts 
Treasury Stock 
Accounting for Treasury Stock 
Donation Account 

Chapter XXVIII. Bonded Debt 

General Considerations 
Bond Issues 

Accounting Theories of Bond Issues 
Bonds Acquired by Issuing Company 
Premiums and Discounts on Bond Sales 
Premiums as Deductions from Principal 


XVI 


CONTENTS 


Chapter XXIX. Secured Debt—Unsecured Debt 

Secured Debt 

Real Estate Mortgages 
Chattel Mortgages 
Interest on Mortgaged Debt 
Secured Debt 
Warehouse Receipts 

Unsecured Debt 

Notes and Bills Payable 
Bills Payable 
Memorandum Checks 
Promissory Notes Payable 

Chapter XXX. Accounts Payable—Dividends Payable 

Accounts Payable Records 
Dividends Declared and Unpaid 
Profits Available for Dividends 

Dividends from Income—from Increased Valuations 
Stock Dividends 

Accounting Treatment of Dividends 

Chapter XXXI. Accrued Liabilities—Deferred Credit Items 

Accrued Liabilities 

Taxes, Licenses, Assessments, and Fees 
Classification of Taxes 

(1) Business Taxes 

(2) Property Taxes 

(3) Excise Taxes 

(4) Inheritance Taxes 
Deferred Credit Items 

Chapter XXXII. Reserves and Surplus—Proprietorship Accounts 

Reserves and Surplus 

Distinction Between Reserves and Surplus 
Classification of Reserves 

(1) Reserves for Depreciation 

(2) Operating Reserves 

(3) Reserves for Surplus Contingencies 

(4) Reserves for Redemption of Debt 

(5) Secret Reserves 

(6) Reserves for Exhaustion of Physical Assets 
Creation of Reserves 

Provision for Depreciation 
Provision for Exhaustion 



CONTENTS 


xvii 


Proprietorship Accounts 

Positive and Negative Components 
Drawing Accounts 

PART V—FINANCIAL STATEMENTS 

Chapter XXXIII. Financial Statements Based on Single Entry 

The Statement of Assets and Liabilities 

The Statement of Resources and of Their Application 

Proof of Ledger Assets 

Chapter XXXIV. Trial Balance and Working Balance Sheet 

Trial Balance 

Classified Trial Balance, or Working Balance Sheet 

Chapter XXXV. The Balance Sheet 

Arrangement as to Assets and Liabilities 
Arrangement as to Order of Items 
Variations in Arrangement of Balance Sheet 
Double-Form Balance Sheet 

Periodical Fluctuations in Double-Form Balance Sheet 
Opposition of Balance Sheet Items 
Form of General Balance Sheet 
Reading a Balance Sheet 

Chapter XXXVI. Special Forms of Balance Sheets 

Bank B.alance Sheet 

The Balance Sheet of Life Insurance Companies 

Balance Sheet of Steam Roads Engaged in Interstate Commerce 

Chapter XXXVII. The Statement of Income and Profit and Loss 

Elements of Statement 
Mechanism of Statement 
Comment on the Statement 
Cash Discounts 
Cost of Goods 

Interest as an Element of Cost 
Book Increase of Cost 
Statement in Account Form 

Statement for Steam Roads Engaged in Interstate Traffic 
Statement of Cash Receipts and Disbursements 


XV111 


CONTENTS 


Chapter XXXVIII. The Consolidated Balance Sheet 

“Consolidation” and “Consolidated” Balance Sheets 
Form of Consolidated Balance Sheet 
Formation of Consolidated Balance Sheet 

Chapter XXXIX. The Statement of Affairs 

Appointment of Receivers 

Status of the Statement of Affairs 

Asset Side of Statement 

Liability Side of Statement 

Preparation of Statement of Affairs 

Preparation of Deficiency Account 

Treatment of Reserves 

Arrangement of the Statement of Affairs 

Arrangement of Deficiency Account 

Chapter XL. Realization and Liquidation 

Method of Closing 

Statement of Realization and Liquidation 
Preparation of Realization and Liquidation Account 
Principles Involved 
Peter Post Problem 

Chapter XLI. The Accounts of Fiduciaries 

Academic Theories 
Statutory Provisions 
Executor’s Accounting 
Payment of Debts and Legacies 
The Executor’s Compensation 
Form of Executor’s Account 
Contents of Schedules 

Differentiation Between Principal and Income 

Practical Problems 

(Pages 521 to 575) 



The Applied Theory of Accounts 

Part I—Business Organization 


CHAPTER I 

THE COPARTNERSHIP 

Preliminary 

The study of the theory of accounts presupposes a 
good working knowledge of the laws which regulate busi¬ 
ness—whether conducted by individuals, by associations 
of interest known as copartnerships, or by artificial bodies 
created by law, and known as corporations—as well as of 
the principles of corporation finance. But as it might be 
considered far too optimistic to assume that every stu¬ 
dent, or would-be student, of accounting is thus equipped, 
a brief sketch of the legal characteristics of the several 
types of business organization is given here. 

Sole Proprietorship 

The business rights and privileges of the individual 
seeking wealth independently, are affected only by such 
laws and customs as regulate the ordinary relations of 
men with their fellow-men and with governing bodies. 
Outside of such legal steps as every sole proprietor must 
take to register his business and to comply with local 
police and fiscal regulations, he is at liberty to conduct his 
enterprise as he pleases, provided he does not interfere 
with the rights of others, or with public policy. As to 

19 



20 


BUSINESS ORGANIZATION 


partnerships and corporations, their activities, through 
law and time-honored customs, have become subject to 
restrictions which act for the benefit and welfare of their 
members, as well as of outsiders who deal with them. 

The Copartnership 

An association of men in partnership is thus defined 
by Chancellor Kent: “A contract of two or more com¬ 
petent persons to place their money, effects, labor, and 
skill, or some or all of them, in lawful commerce and busi¬ 
ness, and to divide the profits and bear the losses in 
certain proportions.” 

In the Federal courts a copartnership has been spoken 
of as, “A contract of mutual agency, each partner acting as 
a principal in his own behalf, and as an agent for his 
copartners.”* 

There are two broad classes of partnerships: 

1. General Partnerships 

2. Limited Partnerships 

As accountants generally understand the term, a gen¬ 
eral partnership is one in which all the partners are ten¬ 
ants in common, every member sharing with his asso¬ 
ciates the liability for such debts as the firm has incurred 
through the actions of the individual partners as agents 
of the other members. The law of New York says: 
“Every general partner is an agent of the partnership in 
the transaction of business, and has authority to do 
whatever is necessary to carry on the business in the 
ordinary manner.” 

Limited Partnerships 

As distinguished from genera* partnerships, the 
limited partnership is characterized by the inability of 


* Karrick v. Haraman, 168 U. S. 324,328; 18 C. St. 135; 42 L. Ed. 484. 



THE COPARTNERSHIP 


21 


some of its members to act as agents for the others or to 
have any voice whatsoever in the management of the busi¬ 
ness; and also by the limitation of the liability of such 
members to the amounts of the capital contributed by 
them. 

In some states, all the members of a limited partner¬ 
ship are liable only to the extent of the capital which 
they have contributed; but in general, limited partner¬ 
ships must have at least one general partner who is liable 
for any deficiency in the assets available for the liquida¬ 
tion of the partnership liabilities. 

The members of a partnership who enjoy the privi¬ 
lege of limited liability are referred to as “special part¬ 
ners. ” A peculiarity of their status is that they must 
contribute capital to become partners, while general 
partners are not legally bound to contribute anything. In 
many states, the statutes even require special partners to 
contribute “cash,” or “lawful money of the United 
States.” 

The most important of the restrictions to which spe¬ 
cial partners are subject, is that which prohibits them 
from withdrawing their capital in the form of dividends, 
profits, loans, or salaries, etc. If they do so, they forfeit 
the privilege of limitation, and become liable as general 
partners. Further, when at dissolution of the partnership 
the assets are not sufficient to liquidate the liabilities, 
special partners are, in some states, denied the right of 
sharing in the firm’s assets. 

Limited partnerships may have members who while 
enjoying limited liability, are permitted to have a voice 
in the management of the concern. They are called “dor¬ 
mant partners.” Their connection with the concern must 
at all times remain secret, or they lose the privilege of 
limited liability. 

An important distinction between limited and general 


22 


BUSINESS ORGANIZATION 


partnership is, that as soon as insolvency is ascertained an 
injunction may, upon the application of a creditor, be ob¬ 
tained against a limited partnership and a receiver ap¬ 
pointed; whereas, in general partnership-s a creditor has 
no such equitable remedy unless it is shown that by allow¬ 
ing the firm to continue, his interest would be grievously 
injured through mismanagement. While this remedy has 
sometimes been granted to the creditors of a general co¬ 
partnership, it is not generally thought to belong to them 
by right. 

Nominal Partners 

A nominal partner is one who, while not in fact a 
partner of either a general or limited partnership, holds 
himself out to be such, to the prejudice of an innocent 
third party. If the injured party seeks redress, the law 
makes the nominal partner a general partner for the pur¬ 
pose of the particular litigation, and attaches upon him a 
general liability. 

Articles of Copartnership 

In partnerships, whether general or limited, the part¬ 
ners are usually bound by a written agreement, known as 
“Articles of Copartnership,” which purports to regulate 
the actions of the associates, to set forth their duties, 
rights, and privileges, and to define the scope of the en¬ 
terprise. And since copartnerships may be terminated 
otherwise than through insolvency and bankruptcy, by: 
(i) the expiration of the term for which created; (2) 
mutual consent; (3) the death of one of the partners; (4) 
the transfer by a partner of his interest to third persons 
not partners; (5) the contemplated admission of a new 
partner not satisfactory to all the others; and (6) the re¬ 
tirement of one of the partners, it follows that articles of 
partnership, in order to be well drawn, should attempt 





THE COPARTNERSHIP 


23 


to foresee, and to provide for, the conditions which may 
prevail at dissolution. 

The Accountant’s Duty 

It is, however, because articles of copartnership are 
seldom thorough, far-seeing, and clearly expressed, that 
accountants are so often called upon to minister to the 
partnership about to be dissolved, and to certify to, or 
deny, the supposed justice of the claims made by one 
partner against the others. The duty of the accountant 
is to conform to the spirit of the articles binding the 
partners; or, if this be impossible, to interpret the pro¬ 
visions thereof in the sense in which the questions at issue 
are generally understood by similar types of business asso¬ 
ciation; or this, in turn, failing, to seek the assistance of 
the law of partnership, of which the salient points are 
given below. 

t 

The Partnership a Quasi-Legal Entity 

While it is generally understood that partnerships are 
not legal entities, still it seems to be in line with modern 
ideas to consider them as such. Courts of law have re¬ 
ferred to them as “The ideal being, known as the partner¬ 
ship”; the United States Bankruptcy Act appears to con¬ 
sider them as entities capable of being thrown into bank¬ 
ruptcy, although the individual partners may not be. In 
stating accounts before a master or a referee, or in cases 
of litigation between partners, it is customary to open an 
account with the firm; this account is debited with the 
contributions of the partners (but not with the amount 
paid by one partner to another partner personally, for a 
place in the firm) and with all moneys advanced by the 
partners to the firm or spent by them for the benefit of 
the firm as such. 


BUSINESS ORGANIZATION 


24 

Acquisition of Partnership Property 

Everything which the partners contribute in the form 
of capital, either at the incipiency of their relation with 
one another, or subsequently, is considered as property of 
the firm as a whole. 

A 

Although oral agreements may in some cases be 
deemed valid, it appears to be the rule that real property 
owned by a prospective partner, becomes firm property 
only by virtue of a written contract transferring the in¬ 
terest in the land estate from the individual to the firm. 
But when real estate has been acquired with the funds 
and for the purposes of the firm, it is the property of the 
firm, even though the title is in the name of one of the 
partners and there is nothing but a verbal agreement to 
the effect that it was to become the firm’s property. 

Partners’ Debts 

The debts contracted by individual partners, either be¬ 
fore or during the life of the partnership, may become 
debts of the firm by mutual consent. 

General Partnership Rules 

Unless specific provisions to the contrary are inserted 
in the articles of copartnership, or some fact exists tend¬ 
ing to show that the partners intended it otherwise, the 
following rules prevail: 

1. All advances made by individual partners to the 
firm, and all debts incurred by them for the partnership, 
are loans to the copartnership, and make the partners so 
contributing, creditors of the same. As creditors, they are 
entitled to interest on their advances and on such sums as 
they have paid personally for the benefit of the firm as 
such. 


THE COPARTNERSHIP 


25 


2. Interest is not to be credited on the amount of 
capital invested, even though the capital contribution of 
one of the partners is greatly in excess of that of others. 

3. Interest is not to be charged on withdrawals. If, 
however, the amounts withdrawn by a partner are in ex¬ 
cess of the limit allowed, fairness requires that he shall be 
charged with the interest which he has caused the firm to 
lose. 

4. Interest is not to be charged on moneys remain¬ 
ing in the possession of a partner pending dissolution and 
winding up. 

5. If no rate of interest is mentioned, the legal rate 
prevails whenever transactions occur raising the question 
of interest. 

6. Profits and losses are to be shared equally, no mat¬ 
ter how unequal the capital accounts of the partners 
may be. 

7. Partners are not entitled to compensation for their 
services. 

8. All partners have an equal duty to keep books of 
account, each partner having free access thereto. 

Precedence of Claims Against Partnership 

While it is true that an individual partner who has ad¬ 
vanced money to the partnership or expended his own 
money for its benefit, is a creditor of the firm, his claims, 
nevertheless, rank after those of the outside creditors of 
the concern; but they rank before the claims of the private 
creditors of his copartners. 

An undrawn credit account appearing in the books of a 
firm to the benefit of one of the partners, is not to be con¬ 
sidered as his private or separate estate in case of dissolu¬ 
tion of the copartnership, until the firm’s debts have been 
paid. This is all the more essential because individual 


26 


BUSINESS ORGANIZATION 


creditors of a partner appear to have a preferred equity 
in the separate estate of that partner over the creditors of 
the firm. 

Value of the Good-Will 

While numerous court decisions indicate that a surviv¬ 
ing partner has the right to continue to use the firm’s 
name, it seems to be a generally accepted doctrine that if 
the good-will attaching to the name is truly existent and 
has a value, the surviving partner is not entitled to use it 
without compensation to the estate of the deceased. In 
some cases the courts have even gone so far as to say that 
the basis for computing the value of the good-will which 
the firm’s name conveys, should be the annual profits of 
the business prior to the death of the partner.* 

Partnership Paper 

If negotiable paper is within the scope of the firm’s 
business any one member may issue it; if not within the 
scope its issue must be ratified by the other members or 
it is not binding upon the firm. The same is true of 
accommodation paper, guaranty, and suretyship. 

Status of Retiring Partners 

If a retiring partner gives his ex-partners an uncondi¬ 
tional contract of sale, he retains no lien against the 
partnership assets. If the sale is conditional upon specific 
performances he retains a claim upon the assets available 
for distribution to the firm’s creditors. 

All obligations incurred by a firm, or binding upon 
partners who were members at the time of their incur¬ 
rence, are binding upon any such members who retire 
before these obligations are satisfied, even though they 

* Matter of Silkman, 121 N. Y. App. Div. 202; 105 N. Y. Suppl. 872; affirmed 
in 190 N. Y.; 560 N. E. 



THE COPARTNERSHIP 


27 


have not matured at the time of such retirement. This 
holds true even though the partners who purchase the 
interests of those who retire have agreed to liquidate the 
liabilities, and have given the vendors an indemnity bond 
against any liability for the firm’s debts. The law con¬ 
siders retiring partners as sureties for the debts incurred 
while they were of the firm, and considers the bond as an 
indemnity against losses, and not as a covenant against 
liability to suit.* 

Status of Continuing Partners 

The continuing partners are liable for the debts of 
the old firm, jointly with the retiring partners. If. a new 
firm has been organized it is not liable unless by agree¬ 
ment to become so, or unless it performs some act indi¬ 
cating that it intended to hold itself liable. 

Status of Incoming Partners 

Partners coming in after the retirement of other part¬ 
ners, become liable for the debts of the old firm only if 
they agree to undertake such liability, or if they perform 
an act indicating such intent. And it may be considered 
that they agree to become so liable if, upon entering the 
firm, they fail to state their freedom from such liability. 

* Taliaferro v. Brown, n Alabama 702. 



CHAPTER II 


THE CORPORATION—STOCK SECURITIES 

The Corporation Defined 

Chief Justice Marshall thus defines a corporation:* 
“An artificial being, invisible, intangible, and existing only 
in contemplation of law. Being the mere creature of law, 
it possesses only those properties which the charter of its 
creation confers upon it, either expressly or as incidental 
to its very existence. These are such as are supposed 
best calculated to effect the object for which it was 
created. Among the most important are immortality, 
and if the expression may be allowed, individuality; 
properties by which a perpetual succession of many per¬ 
sons are considered as the same, and may act as a single 
individual. They enable a corporation to manage its own 
affairs, and to hold property without the perplexing intri¬ 
cacies, and the hazardous and endless necessities of per¬ 
petual conveyances for the purpose of transmitting it 
from hand to hand. It is chiefly for the purpose of cloth¬ 
ing bodies of men, in succession, with these qualities and 
capacities, that corporations were invented, and are in 
use.” 

Corporations Classified 

Corporations may be divided into stock corporations 
and non-stock corporations. Non-stock corporations in¬ 
clude all chartered associations whose purpose is idealistic, 
religious, charitable, educational, etc., etc. 


* Dartmouth College v. Woodward, (4 Wheat) U. S. 518-636; 4 L. Ed. 629. 

28 



STOCK SECURITIES 


29 


Stock corporations are frequently divided into: 

1. Financial Corporations 

2. Business Corporations 

3. Public Service Corporations 

To fulfil the purpose for which they are created, cor¬ 
porations require capital; this is either contributed by 
individuals, copartnerships, or other corporations, or is 
borrowed; or it may be obtained by both these methods. 

Shares, Capital, and Capital Stock 

To show to what extent individual contributors are 
interested in the wealth of the corporation by virtue of 
their respective contributions, “shares of capital stock” are 
issued to them, having a “par” or nominal value, the 
minimum of which is fixed by statute, the maximum being 
uniformly $100. In the State of New York it is now legal 
to issue common stock without a par value, and preferred 
stock which has no preference as to principal, may also be 
issued without par value.* 

The capital contributed by interested parties is the 
property of the legal entity known as the corporation, 
while the shares of stock are the personal property of 
their holders, and constitute a liability of the corpora¬ 
tion. Thus, when we refer to the “capital” of a corpora¬ 
tion we mean the difference between the assets into which 
the contributions of capital have been converted, and the 
liabilities to outsiders incurred as a result of the activities 
of the corporate being; but when we refer to “capital 
stock” we mean the actual liability of the company to 
shareholders for the capital paid in, or subscribed and 
bound under the law to be paid in; and in addition the 
“potential stock,” that is to say the power given by the 

* See Chapter 351 of the laws of New York, 1912, “An act to amend the 
stock corporation law in relation to corporations having shares of capital stock 
without nominal or par value.” 



30 


BUSINESS ORGANIZATION 


charter to obtain more capital by incurring* a liability to 
stockholders to the full extent of the unissued, but 
authorized capitalization. 

Dividends 

The profits made by the corporation through the 
employment of the capital contributed by the share¬ 
holders, belong to the latter only after the board of di¬ 
rectors has resolved that they shall be distributed as divi¬ 
dends and the resolution has become known outside of the 
board room. When these conditions concur, dividends 
become debts of the corporation, and the shareholders can 
enforce their payment. In business corporations it is cus¬ 
tomary to separate the capital stock and profits by calling 
the latter “surplus.” Banks and financial institutions, 
however, frequently refer to the two items as one, “capital 
and surplus.” This is due to the fact that the surplus of 
banks is usually considered as part of the capital stock 
and that the transfer or the bequest of bank stock is under¬ 
stood to carry with it the surplus earned which has not 
been separated therefrom by the declarations of dividends. 

Kinds of Stock and Its Issue 

The capital stock of corporations is usually divided 
into two classes, common and preferred. Common stock 
is that which has no financial preference over any other 
stock of the company and is generally that to which is 
given the voting power. It confers upon its holders the 
right to participate in the management of the affairs of 
the company through the annual election of a board of 
trustees, or directors, who are to act for the stockholders 
at large. 

The word “preferred,” when applied to stock, means 
that the stock is entitled to first consideration in the dis- 


STOCK SECURITIES 


31 


tribution of profits and assets, either or both, as the case 
may be. Preferred stock may be cumulative as to divi¬ 
dends; it may or it may not have voting power, be re¬ 
deemable at a certain figure on or before a stated period, 
or be convertible into bonds of the corporation. If part 
of the original organization scheme, the issue of preferred 
stock requires no authorization on the part of the com¬ 
mon stockholders; but if it is to be issued after the rights 
of the common stockholders have been established, it 
requires their authorization. 

Corporate capital stock is issued in exchange for a con¬ 
sideration, the nature of which varies according to the 
statutes of individual states, but which may be said to be, 
in the majority of the states: 

(1) Cash or its equivalent, the latter term including 

subscriptions subject to call. 

(2) Property, the valuation of which it is within the 

power of the board of directors to establish. 

(3) Labor or services. 

Stock Subscriptions 

Generally speaking, unconditional subscriptions to cap¬ 
ital stock bind the subscribers, i.e., they can be enforced; 
the issue of certificates of stock upon the strength of a 
subscription agreement, completes the stockholder’s lia¬ 
bility, and he is bound to pay that which he has promised 
to pay. This liability of the stockholder is enforceable by 
the company itself, or by its creditors after insolvency. 
Courts have held that unless particular statutes provide to 
the contrary, “it is not essential that a certificate should 
have been issued, in order to create the relation of share¬ 
holder, provided a contract to take the stock has been 
duly made.” 

It is said that the form of subscription is immaterial, 


32 


BUSINESS ORGANIZATION 


so long as the intention of the parties can be ascertained; 
but in cases where the statutes require that a certain per 
cent of the subscriptions be paid in cash upon subscribing, 
such a payment must be made before the subscription 
agreement becomes binding. 

Capital stock to which a prospective stockholder has 
subscribed, but for which he has not paid, can be declared 
forfeited only if the statutes of the state in which the cor¬ 
poration was created, specifically grant the power of for¬ 
feiture. Even then, the exercise of this corporate right 
should be for the benefit of the corporation, and not for 
that of the stockholders. And this right can be exercised 
only by the board of directors. If the statutes do not pro¬ 
vide for forfeiture, the existence of a provision to that 
effect in the by-laws of the company is invalid. 

The acceptance by a corporation of a subscription to 
its capital stock, makes the subscriber a stockholder of the 
company. Bona fide purchasers of capital stock which 
bears on the face of its certificate a notice that it is fully 
paid, are not liable either to the corporation or to its 
creditors for any amount thereof which might, in truth, 
be unpaid. 

Property Acquired by Stock Issue 

The law of New York says in regard to the matter of 
consideration for stock, that any corporation authorized 
by its charter to purchase property for its use and lawful 
purposes, may issue full-paid non-assessable stock for the 
value of the said property, and that in the absence of 
fraud, the judgment of the directors in regard to the value 
of the property thus acquired shall be conclusive. It also 
requires that whenever a corporation reports on its capital 
stock in compliance with legal provisions, it shall specify 
what amount of stock was issued for property. Unless 
prohibited by statute, corporations may acquire property 


STOCK SECURITIES 


33 

by paying therefor partially in stock and partially in bonds 
and partially in cash. 

Labor or Services as a Consideration 

Labor is thought to include manual or brain labor con¬ 
tributed by contractors, lawyers, financial interests, etc., 
etc., for the benefit of the corporation, and anything 
which the corporation receives in the line of services for 
which it would have to pay. Under this interpretation of 
the law, it would be possible to issue stock for organiza¬ 
tion expenses, for alterations to buildings, for the particu¬ 
lar services rendered by underwriters of corporate stocks 
and bonds, etc., etc. 

Stock Bonuses—Increase or Decrease of Capital Stock 

In general, it is held that a corporation cannot issue 
its shares to its stockholders as a bonus; but in the State 
of New York the issue of unissued stock as a bonus to 
bondholders has been upheld as proper, since it was neces¬ 
sary to the successful flotation of bonds.* The Supreme 
Court of the United States has corroborated the sound¬ 
ness of this principle to the extent of a decision to the 
effect that where a bondholder had obtained stock as con¬ 
sideration for his purchase of bonds at par, he could not 
be made to pay for the stock, provided the par value of 
the bonds was greater than the actual value of the bonds 
and stocks.t 

Capital stock may be increased beyond the issue 
originally authorized, by compliance with the requirements 
of the state statutes. It may be similarly decreased, but 
there is often a statutory provision that the reduced capi¬ 
tal stock shall at least equal the debts of the corporation. 

* Christensen v. Enu, 106 N. Y. 97; 12 N. E. 648; 8 N. Y. St. 682; 60 Am. 
Rep. 429. 

t Handley v. Stutz, 139 U. S. 417; n S. Ct. 53a 



34 


BUSINESS ORGANIZATION 


The statutes of individual states must be consulted in re¬ 
gard to what constitutes the proper legal steps necessary 
to obtain the authorization to increase or decrease the 
capital stock. 

Borrowed Capital—Corporate Bonds 

While the issue of long-time instruments of credit is 
not a prerogative which only corporations enjoy, bonds 
are almost exclusively issued by corporate bodies. Unlike 
stock, they promise to pay a certain sum of principal and 
a certain sum of interest at specified times; and, unlike 
stock, they give their holders the privilege of asserting 
their rights whenever that which they are entitled to has 
not been received. But since this right of the bondholders 
appears to place in jeopardy the preexisting rights of 
stockholders, many states require that all issues of bonds 
be authorized by a two-thirds vote of the stockholders. 

Bonds are, generally speaking, long-time promissory 
notes bearing interest at a stated rate, issued serially in 
units of like denomination, payable to bearer or to a 
person registered on the books of the company issuing 
them, pledging to the aggregate of the bondholders cer¬ 
tain specific properties described cursorily in the note 
itself, and in full detail in the contract which gives the 
trustee the right to sell the pledge for the^ benefit of the 
holders of the notes if either principal or interest is de¬ 
faulted at maturity. 

Classification of Bonds as to Security 

There are, however, certain classes of bonds which may 
or may not pledge property to secure the principal of the 
note, and which pledge no property whatever to secure 
the interest. Bonds may thus be divided into three gen¬ 
eral classes: 


STOCK SECURITIES 


35 


1. Secured Bonds 

a. Pledging personal property 

b. Pledging real property 

c. Pledging both real and personal property 

2. Partly Secured Bonds 

a. Unsecured as to interest but 

Secured or preferred as to principal 

3. Unsecured Bonds both as to principal and as to 

interest 

x. Secured Bonds 

a. Pledging Personal Property: 

(1) Debenture Bonds of Financial Institutions. These 
bonds pledge first mortgages owned by the company 
which issues the instruments of credit. The rate of inter¬ 
est which these bonds carry is, of course, less than the 
borrowing company obtains on its own investments in 
first mortgages. 

(2) Collateral Trust Bonds. The pledge in this case 
consists of personal property, such as stocks, bonds, mort¬ 
gages, etc., owned by the borrowing company, and placed 
by it in the hands of a trustee, in accordance with the 
terms of a contract which provides for the sale of the 
pledge for the benefit of the bondholders, upon default by 
the borrower of either principal or interest. 

(3) Equipment Bonds. Until recent years, the form 
of these bonds did not vary materially from that of other 
bonds. They were issued for periods running from ten to 
fifteen years, and were repayable in total at maturity. 
They pledged the very equipment for the acquisition of 
which they had been issued. Lately these bonds have 
assumed a character which places them in a class by them¬ 
selves. They are known as “Car Trust” or “Equipment 
Trust Certificates.” They are frequently repayable in in¬ 
stalments, the security pledged under the issue as a whole 


BUSINESS ORGANIZATION 


36 

reverting, after payment of each instalment, to the unre¬ 
tired proportion. The equipment pledged by the inden¬ 
ture is earmarked individually by means of a plate bear¬ 
ing the name of the trustee in whom title rests until pay¬ 
ment of all the obligations under the issue. When re¬ 
payable in instalments, they are issued in series marked 
“A,” “B,” “C,” etc. 

b. Pledging Real Property: 

(1) Real Estate Bonds. When issued by public service 
corporations, these bonds are secured by such parcels of 
real estate as are not required for the operations of the 
company. When issued by other companies, the above 
distinction does not necessarily apply. 

(2) Land Grant Bonds. The pledge, under these in¬ 
struments of credit, is the landed estate which common 
carriers receive sometimes as a donation, either from the 
government, from municipalities, or from large business 
interests, in consideration of the value of the public 
services which they render. 

(3) Terminal Bonds. These pledge the land and the 
buildings which constitute what is generally known as the 
“terminal facilities” of transportation companies. 

c. Pledging Both Real and Personal Property: 

(1) General Mortgage Bonds. They offer as a secur¬ 
ity the whole physical property of the company, present or 
to come, whether real or personal. 

(2) Blanket Mortgage Bonds. They cover the whole 
property of a railroad system, subject to such prior liens as 
attach to parts thereof. If they contain specific provisions 

b 

compelling the retirement of prior liens at maturity, they, 
in time, become first mortgages; otherwise, not. 

(3) Divisional Bonds. These are special to railroads 
which, in the course of their development, have absorbed 


STOCK SECURITIES 


37 


other lines now forming' subdivisions of the system as a 
whole. The bonds which mortgaged the property at the 
time of its absorption by the greater system, are known 
as “divisional.” 

(4) Purchase Money Mortgage Bonds. These bonds 
pledge the very property for the partial payment of which 
they were issued. 

2. Partly Secured Bonds 

a. Income Bonds. The mortgage recites, either that 
there is pledged some specific property as a security for 
the repayment of the principal, or merely that the bonds 
constitute a preference claim on the property of the com¬ 
pany. As to the interest on the bonds, its payment de¬ 
pends entirely upon the existence of net profits; if net 
profits do not exist in any given period, the right of the 
bondholders may or may not cumulate, according to the 
terms of the indenture. 

3. Unsecured Bonds 

a. Railroad Debentures. These bonds are nothing 
more than a formal acknowledgment of a debt, under seal. 
In regard to the interest payable thereunder, they present 
the same general characteristics as income bonds. 

Typical Bond Issues 

In regard to their ultimate disposition, bonds are often 
referred to as “redeemable” and “convertible,” while the 
names borne by certain other bonds indicate that they 
came into existence as a result of financing operations the 
nature of which is shown by the title appended to the in¬ 
struments. To the latter category belong, consolidated 
bonds, refunding bonds, and interest bonds. 

Redeemable bonds can be repaid by the company 
liable under them, at the end of a period shorter than the 


38 


BUSINESS ORGANIZATION 


life indicated on their face. The right of redemption be¬ 
fore maturity belongs to the maker, and not to the bond¬ 
holder. 

Bonds are said to be convertible when, according to 
the terms of the indenture, they can be exchanged, at the 
option of the holder issuing them, for some other form 
of obligation, such, for instance, as preferred stock. 

An issue of consolidated bonds takes the place of sev¬ 
eral prior issues, and consolidates the pledges given as a 
security for the individual issues to be retired. 

Refunding bonds, as their name indicates, are issued 
in lieu of maturing obligations; they may either be ex¬ 
changed for the maturing bonds, or sold in order that the 
proceeds may be applied to the retirement of the obliga¬ 
tions. In either case, the same property is pledged as ap¬ 
plied to the redeemed instruments. 

Interest bonds, as their name suggests, are issued in 
payment of interest obligations maturing under other 
bonds which cannot be met otherwise. 

Bonds may carry as many interest coupons as there 
are interest periods during their life, or they may carry no 
coupons at all. In the first instance, they are called 
coupon bonds; in the second instance, they are known as 
registered bonds. 


CHAPTER III 


THE CORPORATION—ORGANIZATION AND 

MANAGEMENT 


Corporate By-Laws 

As it would be manifestly impossible for the stock¬ 
holders to manage the affairs of the corporation, and as, 
besides, they are not recognized by law as agents of the 
corporate body, they elect a board of directors whose duty 
it is to manage the corporate affairs. This board exercises 
its functions by appointing officers to whom it delegates 
part of its powers; and in order that the rights and duties 
of all may be well defined and understood, by-laws are 
enacted which, in so far as they do not conflict with the 
laws of the land, are the laws regulating the relations of 
the stockholders with the directors, of the directors with 
the stockholders and officers, and in some cases of the 
corporation with outsiders who have knowledge of the 
existence and import of the by-laws and are thus supposed 
to accept their validity. Unless vested in the board of 
directors by the statutes of the particular state in which 
the corporation is formed, or by the charter of the cor¬ 
poration, the right to make by-laws belongs to the stock¬ 
holders. 

% 

The Board of Directors 

Speaking generally, after the stockholders have elected 
a board of directors, they cannot act otherwise than 
through that board; and in the absence of restricting by- 

39 


40 


BUSINESS ORGANIZATION 


laws the board has practically the same powers as the cor¬ 
poration. Directors do not, however, possess the right to 
encroach upon powers that have been given to stock¬ 
holders by statute, such, for instance, as the right to re¬ 
move a director, to increase or decrease capital stock, to 
dissolve the company, etc. They cannot, unless authorized 
by statute, amend by-laws, or make, without consent of 
the stockholders, any change in the authorized capital 
stock of the company. If the corporation has that power, 
the directors may direct the purchase of the company’s 
capital stock in the open market, and hold it in the treas¬ 
ury subject to resale, but they cannot order it canceled; 
they must hold it unextinguished. They cannot cancel 
subscriptions to stock without consent of the stock¬ 
holders; issue more stock than is authorized; execute 
leases which amount practically to divesting the corpora¬ 
tion of its physical assets; issue stock for less than par, 
unless the statutes permit of the contrary; declare unlaw¬ 
ful dividends, or vote by proxy at meetings of the 
directors. 

The directors possess the power to borrow money 
and to pledge therefor the assets of the company, except 
when the by-laws prohibit it; to create new debts to pay 
off old debts; to lease corporate property if such lease does 
not deprive the corporation of the power to conduct its 
own business; to use their discretion as to the extent of 
the dividends to be paid out of the surplus earned; to 
conduct corporate litigation at the expense of the cor¬ 
poration; to ratify a debt which has been barred by the 
statute of limitation; to make and transfer negotiable 
paper; to fix the salaries of the corporate officers; to pay 
wages in advance; and, unless prevented by the corporate 
by-laws, to make contracts for periods of one year or more, 
with persons who have services to hire or to sell. 


CORPORATE ORGANIZATION AND MANAGEMENT 

Courts qf equity are prone to consider directors as the 
trustees of the stockholders as well as of the creditors of 
the corporation. 1 his gives to their functions a fiduciary 
character which places them in a position where they 
may not secure for themselves any advantage which the 
stockholders cannot share, or which would cause the 
rights of the creditors to become inferior to theirs. It has 
even been held that a director who acquires for himself 
property which it was his duty to acquire for the corpora¬ 
tion, holds it as a trustee for the corporation precisely as 
if he had acquired property belonging to the corporation.* 

Stockholders 

Stockholders have the common-law right to make the 
by-laws of the corporation. In some states the statutes 
delegate the right to the board of directors. They may 
insist upon, certificates of stock being issued to them as 
evidence of the liability which the corporate entity has 
contracted towards them. In some states they are 
authorized to issue preferred stock by appropriate proce¬ 
dure. They have a common-law right to inspect the rec¬ 
ords of the company, but this has been restricted by 
statute and by the courts, and usually a good reason for 
such inspection must be shown. A stockholder has the 
right to subscribe to his due proportion of all increases 
of capital stock. Unless the statutes or the by-laws of the 
company specifically authorize mortgages by a vote of the 
directorate, the directors cannot jeopardize the rights of 
the stockholders by issuing such obligations without the 
authorization of at least two-thirds of the stockholders 
assembled at a special meeting. 

In the event of insolvency the stockholders are liable 
for the difference between that which they have paid, and 
that which they should have paid to make their stock 


* Robinson v. Jewett, 116 N. Y. 40; 22 N. E. 224. 



42 


BUSINESS ORGANIZATION 


“full-paid,” even though the company had agreed to ac¬ 
cept the payments made as full consideration. 

Corporate Officers 

The number, the titles, and the powers of the cor¬ 
porate officers, vary materially according to the im¬ 
portance and to the internal organization of corporations. 
They are, usually: the president, one or several vice-presi¬ 
dents, the secretary, the treasurer, and the auditor. 

The President. In corporations in which the board of 
directors is active, the president exercises merely the 
functions of an officer presiding over the deliberations of 
that body, and of the meetings of stockholders. In cor¬ 
porations where the board is inactive, the president has 
the power of a general agent of the corporation. The 
nature of this power depends upon the character of the 
particular enterprise, and upon business custom. 

The Vice-President. This officer has, at law, no special 
function or power, except when taking the place of the 
president. Corporate by-laws may, however, render his 
office active and important. 

The Secretary. The duties and importance of the sec¬ 
retary’s office is determined by the corporate by-laws. 
Generally speaking, he signs certificates of stock, keeps 
the corporate seal and the corporate records, reports the 
deliberations of the board of directors and of the meetings 
of stockholders. He signs or attests, or both, all sealed 
instruments of the corporation, and issues all official 
notices of meetings. 

The Treasurer. As the name indicates, the treasurer 
has charge of the corporate finances. He usually has the 
power to sign checks, to select depositories when the 
board has not acted, and to sign jointly with the presi¬ 
dent, or other officer, all instruments pertaining to 
finances. 


CORPORATE ORGANIZATION AND MANAGEMENT 43 

The Auditor. This officer has charge of all matters 
pertaining to the keeping of the financial records. He 
plans books of account, devises methods of recording and 
accounting best calculated to fulfil the purpose of the 
company, and watches over the faithful recording of all 
facts. He submits, at stated periods, statements showing 
the financial status of the enterprise, and the causes which 
have contributed to its success or to its failure. 


CHAPTER IV 


THE CORPORATE RECORDS 

Statutory Requirements 

The financial records which a concern may keep— 
whether partnership or corporation—will be considered at 
length in the course of this book. But inasmuch as the 
corporate books have little to do with accounting prin¬ 
ciples, it may be well to treat of them at this point. 

The requirements in regard to the number and form 
of corporate books vary greatly in the different states. Gen¬ 
erally speaking, it may be said that the scheme of corporate 
accounting comprises: 

1. Minute Book 

2. Subscription Ledger 

3. Stock Certificate Book 

4. Stock Book or Stock Ledger 

5. Corporate or Stock Journal 

6. Stock Transfer Book 

1. Minute Book 

The minute book should record the facts in connection 
with the organization of the company, the framing and the 
amendment of the by-laws, the election of the directors, 
the appointment of officers and ministerial agents, and a 
true history of the meetings, deliberations, and resolutions 
of the board of directors and of the stockholders. The 
facts recorded should be expressed in clear, unequivocal 
language. The book is usually kept by the secretary of 

44 



THE CORPORATE RECORDS 



Figure I. Subscription Ledger 


































































46 


BUSINESS ORGANIZATION 


the company; it has no special form, and may consist of a 
scrap-book in which the minutes are pasted after having 
been typewritten. A loose-leaf minute book is the most 
convenient form. 

2. Subscription Ledger 

When the subscriptions to capital stock are numerous, 
and subject to calls extending over a period of several 
months, it is necessary that an account be kept with every 
subscriber and every instalment. The arrangement of the 
ledger in which these accounts will be kept is essentially 
a matter of convenience. It may be, for instance, as 
shown in Figure i. 

3. Stock Certificate Book 

This book, which must be bound, contains the blank 
certificate to be issued; each certificate is attached to a 
stub, a perforated line running vertically between the two 
parts of the document. 




1 

1 

1 


Binding 

Stub 

1 

1 

1 

1 

1 

1 

1 

1 

1 

1 

1 

Certificate 


Figure 2. Arrangement of Stock Certificate Book 


The stub contains reference to the number of the 
certificate, the amount of shares which it stands for, the 
date of issue, and the name and address of the stockholder. 
It may state the consideration for the issue, or merely the 
fact that the stock was part of an “Original Issue.” It 
provides for the necessary information in connection with 
registered transfers of stock from a stockholder to an- 






THE CORPORATE RECORDS 


4 7 


other, for the signature of the stockholder receiving the 
certificate which corresponds to the stub, and for the date 
of delivery. 


Certificate No. 140 
No. of Shares 50 
Issued: 

On May I, 1912 
To John Doe 
Address: Astoria, L. I. 

For: Property 

From whom transferred: 

Name. 

Address.. 

Date. 

No. of Original Certificate. 

No. of shares of Original Certificate. 

No. of shares transferred. 

Received Certificate No. 140 for 50 shares 
Date, May 1, 1912 
Signature John Doe 


Figure j. Stock Certificate Stub 

The certificate itself is a more or less elaborate docu¬ 
ment, bearing the name of the issuing company, reciting 
the authorized issue of which it is part, the class of stock 
which it represents (preferred or common), stating 
whether or not it is full-paid and non-assessable, and the 
par value of each share. If the stock is preferred, the 
certificate may recite the details of the issue. 

The stock certificate certifies, under the common seal 
of the corporation and the signatures of authorized offi¬ 
cers, that the person whose name appears on its face is the 
owner of so many shares of capital stock of the company. 
It states the conditions under which it is transferable, and 
bears on its back a blank form for the assignment of the 
stock. 












BUSINESS ORGANIZATION 

4. Stock Book or Stock Ledger 

The stock book (Figs. 4-7) must be so arranged as to 
comply with the provisions of the statutes of the particu¬ 
lar state in which the corporate charter was granted. The 
law of the State of New York requires that the book con¬ 
tain the names, alphabetically arranged, of all persons who 
are stockholders of the corporation, showing their places 
of residence, the number of shares of stock held by them 
respectively, the time when they respectively became the 
owners thereof, and the amount paid thereon. It also re¬ 
quires that the stock book shall be open daily, during at 
least three business hours, for the inspection of its stock¬ 
holders and judgment creditors, who may make extracts 
therefrom. 

The keeping of a Capital Stock Balance account in the 
stock book, as shown in Figure 4, is not required by law, 
nor is it necessary to meet the demands of the stock¬ 
holders and judgment creditors; it has, nevertheless, the 
advantage of making the stock book self-balancing, and 
of corroborating the accuracy of the financial ledger in 
connection with the amount of capital stock issued and 
outstanding. The crediting of the shares issued to the 
account of the individual creditors, is not a matter of ac¬ 
counting principles; it is, however, a matter of common 
sense, since the corporation is liable to the stockholder for 
the capital stock issued to him. 

5. Corporate (or Stock) Journal 

This book (Figure 8) is used only by corporations 
whose stock is very active. It makes it possible to gather 
daily the capital stock transactions which have taken place 
both at the office of the company and at the offices of the 
duly appointed transfer agents, and to transfer them 
quickly and accurately to the capital stock ledger. The 
accounting is done in shares, not in money amounts. 



CAPITAL STOCK BALANCE! ACCOUNT 


THE CORPORATE RECORDS 


49 




Figure 4> 5- Stock Book Accounts 


















































































50 


BUSINESS ORGANIZATION 









Figures 6, /. Stock Book Accounts 






















































































THE CORPORATE RECORDS 


51 









































































































( Name of Company) 


52 


BUSINESS ORGANIZATION 


* 


I 


Number and face Value of Stamps 

0 

£ 











Y 


















S 

•#» 















O 

<* 













































6 

5 ) 











\ 




0 

0 












\ 



0 

0 












r 



0 















d 















Number 

of 

Shams 















i! 

orzt 















To Whom Issued 













» 


0 

11 

tO 











1 




Number 

of 

Shanes 















5 erial 

Number 

of 

Canceled 

Certificate 















£ 

(0 

0 

























\ 





Figure p. New York Stock Transfer Book 















































































THE CORPORATE RECORDS 


53 


6. Stock Transfer Book 

The law of New York prescribes that: 

Every corporation or its transfer agent shall keep a 
just and true book of account in the form prescribed by 
the comptroller, wherein shall be plainly and legibly 
recorded in separate columns: 

1. The date of making every transfer of stock 

2. The name of the stock and the number of shares 

thereof 

3. The serial number of each surrendered certificate 

4. The serial number of the certificate issued in ex¬ 

change therefor 

5. The number of shares represented by said certifi¬ 

cate 

6. The name of the party to whom said certificate 

was issued 

7. The number and face value of the adhesive 

stamps as affixed and required by the statute 

It shall also keep and retain a stock certificate book 
and all surrendered or canceled shares or certificates of its 
stock and memoranda relating to the sale thereof, for a 
period of two years from the date of the delivery thereof. 

The requirements as to the stock transfer book vary 
in the different states. In New York the prescribed form of 
stock transfer book to be kept by corporations and transfer 
agents is shown on the preceding page. 


Part II—The General Theory and Technique 

of Accounts 


CHAPTER V 

ACCOUNTING SYSTEMS—SINGLE ENTRY 

The Principles of Single Entry 

The purpose of single-entry bookkeeping is to record 
all the transactions of a business, but to keep running 
ledger accounts with persons only; that is to say, with the 
proprietor, the persons who enter into business relations 
with him (his customers), and the persons with whom he 
enters into business relations (his creditors). To other 
invested values, not found in the ledger but ascertainable 
by means of analysis of books of first record or through 
periodical inventories, is left the duty of reflecting, at the 
end of the accounting period, the increases and decreases 
which they have individually received or suffered. 

The basic principles of the system are: 

1. Increases of positive values (assets), plus decreases 
of negative values (liabilities), as revealed by inventories 
and by the accounts with persons, give all the factors 
which have increased the wealth of the proprietor. 

2. Decreases of positive values, plus increases of neg¬ 
ative values, as revealed by inventories and by the ac¬ 
counts with persons, give all the factors which have de¬ 
creased the wealth of the proprietor. 

54 



SINGLE ENTRY 


55 


3. Decreases of positive values, plus increases of nega¬ 
tive values, represent the resources which the proprietor 
has applied to obtain the factors which have contributed 
to the net increase of his wealth. 

Single-Entry Ledger Accounts 

Running ledger accounts with persons are to be so 
kept as to show clearly: 

1. For the Proprietor: 

a. The net amount of the values originally in¬ 

vested by him in the business, represent¬ 
ing what he owns or is due to him, minus 
what he owes. 

b. The increases or decreases of the values 

originally invested by him, resulting from 
the operations of the accounting period. 

2 . For the Customers and Creditors: 

a. The amount receivable from them or pay¬ 

able to them by the proprietor, at the in- 
cipiency of their business relations with 
him. 

b. The changes occurring in the indebtedness 

of the parties as a result of the operations 
of the accounting period. 

Debits and Credits 

Under the rules of bookkeeping by the single-entry 
system, the proprietor credits his capital account, at the 
beginning of business, with his net investment. There¬ 
after, the increases or decreases of the personal accounts 
of the proprietor, of the customers, and of the creditors, 
are recorded in the ledger by means of debits and credits 
to the accounts, as indicated by the day book (or journal), 
which contains the daily recital of all the transactions. 


^6 THEORY AND TECHNIQUE OF ACCOUNTS 

By debit, is meant: 

I. The recording by the proprietor, in a ledger ac¬ 
count with a person, of claims against that 
person arising from the sale of merchandise. 

2o The recording by the proprietor, of the reduction, 
or of the settlement in full, of a claim payable 
to a person who has extended credit to him for 
merchandise purchased. 

3. The recording by the proprietor, in his own 
account, of the net decrease of the values in¬ 
vested by him. 

By credit, is meant: 

1. The recording by the proprietor, of the reduc¬ 

tion, or of the settlement in full, of his claim 
against a customer, arising from the receipt of 
money or its equivalent. 

2. The recording by the proprietor, of a debt which 

he has incurred through purchase on credit. 

3. The recording by the proprietor, in his own ac¬ 

count, of the net increase of the value invested 
by him. 

The Effect of Debits and Credits 

Crediting the proprietor’s account with his net invest¬ 
ment at the beginning of operations, gives precisely the 
same result as crediting him with his assets and debiting 
him with his liabilities. 

Debiting a customer with a claim against him of, say, 
$60 obtained in exchange for merchandise costing, say, 
$40, sold to him on credit, gives the same result as debit¬ 
ing the proprietor with the cost of the merchandise which 
has gone out of the business, and crediting him with the 
new value (representing the cost of the value parted with, 
plus profits on sale) which has come into the business 
under the form of a claim against a person. 


SINGLE ENTRY 


57 


Crediting a customer with the settlement of his debt 
to the proprietor, amounts to the same thing as debiting 
the proprietor with the asset with which he has parted, 
i.e., a claim against a person, and crediting him with the 
new asset which has come in, whether this new asset be cash 
or its equivalent. 

Crediting a creditor with the value of the goods sold 
by him on credit to the proprietor, is equivalent to debit¬ 
ing the proprietor with the new liability which he has in¬ 
curred, and crediting him with the new asset which he has 
obtained in return. 

Debiting a creditor with the settlement of his claim 
amounts to crediting the proprietor with the liability 
which he has liquidated, and debiting him with the 
amount of cash, or its equivalent, with which he has parted 
as a result of the transaction. 

Crediting the proprietor at the end of the period with 
the net increase of the values invested by him at the be¬ 
ginning, is equivalent to crediting him, in detail, with all 
the increases of assets plus the decreases of liabilities, and 
debiting him with all the decreases of assets plus the in¬ 
creases of liabilities. This, in turn, is identical to crediting 
him in detail during the accounting period, with all the 
values which have come into the business, and debiting 
him with all the values which have gone out of the busi¬ 
ness. By “values” as used here, is meant not only tangible 
values, but, as well, increases or decreases of the proprie¬ 
tor’s equity in his assets. Since the debts of the proprie¬ 
tor constitute liens against his assets, it follows that when 
he liquidates a liability there has gone out of the business 
cash, or its equivalent; but there has come into the busi¬ 
ness a new value, that is to say, an increase of equity in 
the form of the decrease of a debt, which is to his benefit 
and with which he is to be credited. 


THEORY AND TECHNIQUE OF ACCOUNTS 


Equations of Single-Entry System 

The system of single-entry bookkeeping is reducible 
to the following equations: 

1. Initial assets less initial liabilities = initial net 

worth. 

2. Increases of assets plus decreases of liabilities = 

factors in favor of the proprietor. 

3. Decreases of assets plus increases of liabilities = 

factors against the proprietor. 

4. Factors for the period in favor of the proprietor 

less factors for the period against the proprietor 
= net increase of net worth. 

5. Assets at end of the period less liabilities at end 

of the period = net worth at the end of the 
period. 

6. Net worth at the end of the period less net worth 

at beginning of the period = net increase of net 
worth during the period. 

In connection with equation 6, it must be said that the 
net increase of the net worth does not necessarily indicate 
the extent of the profits obtained. If, for instance, new 
capital contributions or withdrawals of capital have taken 
place during the period, the profits would be: 

In the first instance: 

Net increase of net worth less contributions of 
capital. 

In the second instance: 

Net increase of capital plus withdrawals of capital. 

Sources of Gains and Losses Not Shown 

It would appear from the foregoing, that while the 
single-entry system makes it possible to obtain the 
amount of profits (or losses) of a given period, and to sup- 


SINGLE ENTRY 


59 


port it, on the one hand, by the detail of the increases of 
assets added to the decrease of liabilities, and, on the 
other hand, by the detail of the decreases of assets added 
to the increases of liabilities, the causes which have 
brought about the increases and decreases are not obtain¬ 
able. That this is the opinion of a great many writers of 
accounting, could be shown by a multitude of quotations. 
It has been said that single entry “fails to fulfil the object 
of bookkeeping, in that it does not exhibit the true finan¬ 
cial condition of the business, and is incapable of proof of 
accuracy.” Lisle says in “Accounting in Theory and 
Practice,” that “no detailed Profit and Loss account 
can as a rule be prepared, and there is no satisfactory 
check on the accuracy of the results, as is provided by the 
balancing of the books which have been kept by double 
entry.” Greendlinger asserts that “many evils continue 
to exist although we know them to be such. Single entry 
is certainly an evil in modern accountancy, and account¬ 
ants greatly discourage its use—the disadvantages of the 
method are not lessened if it is used by a small rather than 
by a large concern.” 

Notwithstanding the above quotations, it would be 
wrong to suppose that the single-entry system is of slight 
use. The fact that it was in vogue in Italy, the birthplace 
of double entry, up to the year 1869 when a law made the 
adoption of the latter system compulsory in so far at least 
as the accounts of the Italian government were concerned, 
seems to indicate that it is more serviceable than it is 
generally supposed. 

Proprietor’s Account 

It has been said that, if properly kept, the proprietor’s 
account appearing in a single-entry ledger can be made to 
reflect, during the accounting period, all the facts which 
it is necessary to know at the end. It may be of interest 


6o THEORY AND TECHNIQUE OF ACCOUNTS 


and of some value to take simple, familiar factors, and see 
how they can be handled in order to prove this contention. 
We will consider: 

1. Purchases 

2. Sales 

3. Cash Receipts 

4. Cash Disbursements 

5. Promissory Notes 

as to the effect of the transactions involved, upon both 
the proprietor’s account, and the personal accounts of 
creditors and customers. 

1. Purchases 

a. Credited to the creditors to record their 

claim against the proprietor. 

b. Credited to the proprietor as representing 

an asset acquired during the period. 

2. Charge Sales 

a. Debited to customers at sales price to re¬ 

cord the proprietor’s claim against per¬ 
sons for merchandise. 

b. Debited to the proprietor at cost as repre¬ 

senting the value of the asset which has 
been parted with; or debited to the pro¬ 
prietor at sales price, the profit realized 
on the sale being further credited to him 
as representing the excess value of the 
assets which he has received through the 
exchange over the value of the assets 
with which he has parted. 

3. Cash Receipts (Cash Sales) 

a. Cash received from customers, credited to 
them to show the reduction of the pro-, 
prietor’s claim, and credited also to the 
proprietor as representing an asset which 
has come into the business. 


SINGLE ENTRY 


6l 


b. Cash received on account of cash sales, 
credited to the proprietor as represent¬ 
ing the proceeds of an asset which has 
gone out; at the same time merchandise 
sold, debited to the proprietor at cost as 
representing the value of the asset which 
has been sold. 

C. Cash received in the form of credits by 
banks for interest, credited to the pro¬ 
prietor as representing the gain made on 
investments of cash, etc. 

4. Cash Disbursements 

a. Cash paid to creditors, debited to them to 

show the reduction of their claims 
against the proprietor, and debited also 
to the proprietor as representing an 
asset which has gone out of the business. 

b. Cash paid for expenses, debited to the pro¬ 

prietor as representing the cost to him of 
conducting his business, etc. 

5. Promissory Notes 

a. Received; credited to the customers who 

give them, and credited also to the pro¬ 
prietor as representing a new asset which 
has come in. 

b. Collected; treated both as a debit and as a 

credit to the proprietor, to record the 
exchange of one asset for another. 

C. Issued by the proprietor; debited to the 
creditor to whom issued, and also to pro¬ 
prietor as representing a new liability. 

d. Paid; treated both as a debit and as a 
credit to the proprietor, to record the 
loss of cash and, at the same time, the de¬ 
crease of a liability. 


62 THEORY AND TECHNIQUE OF ACCOUNTS 


Closing the Accounts 

The method of handling the accounts at the close of 
the period is as follows: 

1. Customers. The balance of their accounts, less 
the balance at the beginning of the period, if any, credited 
to the proprietor at the close of the period; claims against 
customers being the only asset not directly credited to 
him during the period. 

2. Creditors. The balance of their accounts, less the 
balance at the beginning of the period, if any, debited to 
the proprietor at the close of the period; creditors’ claims 
being the only liability not directly debited to him during 
the period. 

3. Closing Inventory of Merchandise. Ignored in 
so far as the proprietor’s account is concerned, since it is 
already included therein. This is obvious, for if the pro¬ 
prietor’s account as it stands has been credited with initial 
inventory, plus purchases, and debited with sales at cost 
(or debited with sales at sales price, and credited with 
profits on sales at time of sales), the excess credits over 
debits on account of merchandise represent the closing 
inventory. 

4. Proprietor’s Account. Closed at the end of the 
period by inserting on the debit side “Balance” represent¬ 
ing the net investment which must be supported by a 
statement of assets and liabilities; and reopened for the 
new period by crediting the proprietor with all his assets, 
and debiting him with all his liabilities as shown by the in¬ 
ventory of all the values, positive and negative. 

Practicability of System 

That such a system can be used is evidenced by the 
fact that the principle of the proprietor’s account as given 
above forms the basis of the quadruple-entry systems 
known as Logismography and Statmography, evolved in 



SINGLE ENTRY 


6 3 

Italy only a few years ago, one of the objects of which is 
to reflect the net worth of the proprietorship at all times 
without having to take inventories. That the principles 
underlying the above treatment of the proprietor’s ac¬ 
count are correct, is shown by the following examples: 


John Harrison, Proprietor—Single-Entry Ledger 

Classified Transactions 


1912 
Jan. 1 




1912 


Jan. 1 
to 

June 30 


Liabilities: 


Jan. 

1 Assets In- 


Mortgage 



vested: 


Payable ... 

$5,000.00 


Cash . 

$7,500.00 

Notes Pay- 



Merchandise. 

1,000.00 

able . 

3,000.00 


Land and 


Creditors ... 

2,000.00 


Building... 

13,000.00 

Net Investment 

15,000.00 


Horse, Wag- 





on and 





Harness .. 

2,000.00 




Furniture and 

. 




Fixtures .. 

1,500.00 

Total. 

$25,000.00 


Total. 

$25,000.00 



Jan. 

1 Net Investment $15,000.00 

Assets Parted 


to 



with During 


June 30 Net Assets Ac- 


the Period: 



quired Dur- 


Merchandise, 



i n g the 


at cost.... 

$9,000.00 


Period: 


Cash: 



Merchandise 


Paid to cred- 



purchased.. 

$12,000.00 

itors . 

9,500.00 


Cash received 


Paid at ma- 



from cus- 


t u r i t y of 



tomers ... 

7,000.00 

notes pay- 



Cash Interest 

50.00 

able. 

3,000.00 


Promissory 


Paid for cur- 



Notes re- 


rent needs. 

300.00 


ceived from 





customers.. 

50.00 




Customers’ 





Accounts*... 

2,950.00 

◦tal. 

$21,800.00 


Total. 

$22,050.00 


* If there had been customers’ accounts at the beginning of the period, only 
the increases would be credited. 


























64 THEORY AND TECHNIQUE OF ACCOUNTS 


John Harrison, Proprietor—Single-Entry Ledger 
Classified Transactions— Continued 


Liabilities 
Incurred 
During the 
Period: 

Promissory 
Notes Pay¬ 
able, issued 
to creditors $1,100.00 
Increase o f 
credi tors’ 
accounts, as 
shown by 


the ledger. 1,400.00 

Total. $2,500.00 

Net Investment $15,750.00 
Total. $40,050.00 


Reduction of 
Liabilities: 

Notes Pay¬ 
able paid.. $3,000.00 


Total. $40,050.00 


If we were to express the factors found in the account of 
the proprietor, we would obtain: 


Merchandise Transactions 


Debits 

Initial Inventory. $ 1,000.00 

Purchases. 12,000.00 


Total debits 


$13,000.00 


Credits 

Cost of goods sold (i.e., purchase cost) 


9,000.00 


Closing Inventory (difference between cost of goods 
purchased and cost of the part of these goods which 
was sold) . 


$4,000.00 
























SINGLE ENTRY 


65 


Transactions with Customers 


Debits 

Initial Balance.(none) $. 

Sales: 

Settled for in cash. 7,000.00 

Settled for by notes. 50.00 

Balance carried on open accounts. 2,950.00 


Total debits. $10,000.00 

Credits 

Cash Received. $7,000.00 

Promissory Notes. 50.00 


Total credits 


7,050.00 


Balance due by customers 


$2,950.00 


Transactions with Creditors 


Credits 

Initial Balance... $2,000.00 

Purchases . 12,000.00 


Total credits... $14,000.00 

Debits 

Cash paid to them. $9,500.00 

Promissory Notes. 1,100.00 


Total debits 


10,600.00 


Balance due to creditors 


$3,400.00 


Transactions in Promissory Notes Receivable 

Received from customers, not matured, not discounted.. $50.00 


Transactions in Promissory Notes Payable 


Credits 

Initial Balance. $3,000.00 

Given to creditors in settlement of their 
accounts. 1,100.00 


Total credits 


$4,100.00 



































66 THEORY AND TECHNIQUE OF ACCOUNTS 


Transactions in Promissory Notes Payable— Continued 

Debits 

Paid in cash at maturity. 3,000.00 


Balance outstanding.. $1,100.00 


Cash Transactions 

Debits 

Initial Investment. $7,500.00 

Received from customers. 7,000.00 

Credited by bank for interest. 50.00 


Total debits.,.. $14,550.00 

Credits 

Paid to creditors. $9,500.00 

Paid at maturity of notes payable. 3,000.00 

Paid for current expenses. 300.00 


Total credits. 12,800.00 


Balance on hand. $1,750.00 


Profit and Loss 

(For the period) 

Protits 

Gross profit on merchandise sales. $10,000.00 

Less cost of sales. 9,000.00 


$1,000.00 

Interest on bank balances. 50.00 


Total profits... $1,050.00 

Expenses . 300.00 


Net profit... $750.00 


From the foregoing information we can build up, 
without difficulty, the following statement which has been 
said to be the only form of financial statement possible 
under single entry: 




































SINGLE ENTRY 



Statement of Assets and Liabilities of John Harri¬ 
son, at January i and June 30, 1912, as per his 
Single-Entry Ledger, Books, and Records 


Assets 


Cash . 

Merchandise . 

Land and Building. 

Horse, Wagon and Har- 

January i 
$ 7,500.00 
1,000.00 

13,000.00 

June 30 
$ 1,750.00 
4,000.00 

13,000.00 

Increases 

$3,000.00 

Decreases 

$5,750.00 

ness. 

2,000.00 

1,500.00 

0 non no 



Furniture and Fixtures... 

Sundry Customers. 

Notes Receivable. 

1,500.00 

2,950.00 

50.00 

2,950.00 

50.00 


Total. 

$25,000.00 

$25,250.00 

$6,000.00 

$5,750.00 


Liabilities 



Mortgages Payable. 

Notes Payable. 

Creditors’ Accounts. 

January i 
$ 5,000.00 
3,000.00 

2,000.00 

June 30 
$ 5,000.00 
1,100.00 

3,400.00 

Decreases 

$1,900.00 

Increases 

$1,400.00 

Total. 

$10,000.00 

$ 9,500.00 

$1,900.00 

$1,400.00 

John Harrison, Capital.... 

15,000.00 

15,000.00 



Total. 

$25,000.00 

$24,500.00 



Total Increases and De- 





creases . 



$7,900.00 

$7,150.00 




Net Increase of Investment 



$ 750.00 



From the foregoing, it will be seen that sweeping de¬ 
nunciations of the single-entry system are not fully justified. 

We need not, however, go so far in order to clear 
single entry of the odium cast upon it by unsympathetic 
writers who have sentenced it on the merits of its ledger. 
The ledger is not the only book of record which can be 



































68 THEORY AND TECHNIQUE OF ACCOUNTS 


kept under the system; and if double entry has found it 
necessary to divide its journal into its components, i.e., 
cash, purchases, sales, etc., as we will see later when treat¬ 
ing of the evolution of the books of account, there is no 
reason why single entry could not do the same thing 
and be made highly analytical. Admittedly, the single¬ 
entry ledger is of no great help so far as statements are 
concerned; but few accountants would be willing to admit 
that they could not prepare financial statements from 
books of original entry. A merchandise stock book, a 
cash book, a sales book, and a purchase book are not 
necessary to the proper working of single entry, but they 
can be kept without interfering with the principles and 
purpose of the system. 

It cannot be denied that no trial balance of a single¬ 
entry ledger can be taken if we give to the word “trial 

balance” the sense that it has only when referring to the 

% 

general ledger kept by double entry. It must be admitted 
that errors which creep into single-entry records are not 
readily detected, for there is no equilibrium to be main¬ 
tained; that without a properly kept proprietor’s account, 
the ledger does not show the causes for the increases and 
decreases of assets and liabilities, and that, therefore, 
there can be no profit and loss account in the ledger; that 
the assets and liabilities can be obtained at the end of the 
period only by inventory, or by adding to, or deducting 
from, the assets and liabilities as at the beginning of the 
period, the transactions of the period shown by the sun¬ 
dry records and memoranda. But when all that is ad¬ 
mitted, it remains true that single entry is capable of giv¬ 
ing excellent results. 


CHAPTER VI 


ACCOUNTING SYSTEMS—DOUBLE ENTRY 

The Purpose of Double Entry 

We have seen that the purpose of single entry is to 
record, in the ledger, transactions with persons only. It 
does not concern itself with the effect of such transactions 
upon invested values, since this will be shown by an in¬ 
ventory at the end of the period; nor is it interested in 
individual results and causes, since the only thing of im¬ 
portance is the net increase or decrease of net worth. In 
contradistinction, the purpose of double entry is to record 
in the ledger all financial transactions, of whatever nature 
they may be, and to take into consideration the financial 
fact, its cause, its effect, and its result. 

Principles of Double Entry 

The system is based on the doctrine of equilibrium, 
that is to say that tendency supposed to be inherent in the 
nature of things, which makes them seek to maintain a 
harmonious balance among their sundry elements. Busi¬ 
ness is amenable to the doctrine of equilibrium. To show 
that it has acquired a harmonious balance among its ele¬ 
ments, and maintained it, the recording system known as 
double entry must be employed, of which the following are 
the underlying principles: 

I. Initial equilibrium must be established by bal¬ 
ancing what the proprietor owns, that is to say 
his assets, with: 


69 


JO THEORY AND TECHNIQUE OF ACCOUNTS 

a. What he owes, i.e., his liabilities 

b. His equity in his assets, i.e., his net invest¬ 

ment, or net worth 

2. The initial equilibrium once established, is dis¬ 

turbed whenever a financial transaction occurs. 

3. Every financial transaction may be subdivided 

into two or three parts: 

a. The effect 

b. The counterpart 

c. The result, if any 

4. Every financial transaction has for effect the in¬ 

come or the outgo of financial values. 

5. Incoming or outgoing values are: 

a. Counteracted by outgoing or incoming 

values of a weight: 

(1) Greater than their own; in this case, 
there has been an exchange of values 
resulting in a gain or a loss. 

(2) Smaller than their own; in this case 
there has been an exchange of values 
resulting in a loss or a gain. 

(3) Equal to their own; in this case there 
has been an exchange of values with no 
result. 

b. Counteracted by the receipt or the per¬ 

formance of services, the cost or the value 
of which they measure. 

c. Not counteracted by either income or outgo, 

or by service received or rendered, and as 
a consequence, resulting in a profit or a 
loss. 

A Balancing System 

Thus, the system of double-entry bookkeeping may be 
compared to a balancing scale provided with two weigh- 


DOUBLE ENTRY 


71 


ing dishes, one for the positive (debit) facts, the other 
for negative (credit) facts. As, of necessity, the business 
cannot be carried on unless the positive facts (debits) ex¬ 
ceed the negative facts (credits), it follows that in order 
to establish equilibrium between the two sides of the 
scale, an additional weight must be added on the right 
side to represent the equity of the proprietor in the posi¬ 
tive facts. 

Positive facts assert that the values which they repre¬ 
sent are owned by the proprietor, or that they have been 
expended or lost by him in the course of operations. 
Negative facts deny the ownership asserted by positive 
facts; or they show gains offsetting losses or benefits off¬ 
setting the disappearance of positive values. 

The weighing of transactions, which is necessary in 
order that their effect, their counterpart, and their result 
may be ascertained and recorded in such a way as to re¬ 
establish equilibrium, is performed through the help of 
charges and discharges, that is to say, debits and credits. 
The book in which the debits and the credits are re¬ 
corded is the journal. 

Rules for Journalizing 

The rules for the recording of debits and credits, that 
is to say, the rules for journalizing, are as follows: 

i. At the incipiency of the business: 

a. The business is to be debited in detail with what it 
has received from the proprietor. 

b. The business, being debited with what it has re¬ 
ceived, must, of necessity, be credited in detail with what 
it will be called upon to spend in order that it may meet 
the obligations incurred by the proprietor as a result of 
the acquisition of the wealth which he has invested. 

c. The business, being debited in accordance with the 


72 


THEORY AND TECHNIQUE OF ACCOUNTS 


above rules with all the values invested by the proprietor, 
and credited with what it will have to spend in order to 
retain them, stands, in fact, debited with the proprietor’s 
net wealth; hence, the proprietor must be credited with 
his net investment, in order that equilibrium may be had. 

2. During the course of the accounting period: 

a. The business being charged with such values as 
have been intrusted to it, is, of course, debited with all 
increases in the said values, through the medium of 
proper debits to the particular values which have been 
benefited by the increases. In order that the equilibrium 
thus disturbed may be reestablished, such debts as have 
been incurred, owing to the acquisition of the increases in 
wealth, must be recorded through the medium of proper 
credits to the individual creditors. 

b. The business being debited in detail with all values, 
any change occurring to the benefit of any given value, 
and to the detriment of another, or others, must be re¬ 
corded by debiting the beneficiary, and crediting the 
loser, or losers. 

c. Any reduction in the amount of the values, due to 
the liquidation of the proprietor’s debts, must be shown 
by a debit to the beneficiary of the settlement, and a 
credit to the value which has been decreased. 

d. Any loss sustained is to be credited to the value 
which has been partially or totally lost, and charged to an 
account which will record, during the fiscal period, all the 
losses incurred. 

e. Any gain is to be debited to the value which has 
been increased thereby, and credited to an account which 
will record all the gains made during the period. 

3. At the end of the fiscal period : 

The net amounts of the gains made, as represented by 


DOUBLE ENTRY 


73 


the summary account which shows all losses and gains, 
is now credited to the proprietor. Conversely, if the pre¬ 
ponderance is on the side of losses, the proprietor must 
be debited. The equilibrium which has been disturbed by 
the credit or the debit to the proprietor, is reestablished 
by debiting or crediting the summary account, thereby 
closing it. 

Profit and Loss Account and Nominal Accounts 

Modern bookkeeping has found the Profit and Loss 
account, which is the name given to the summary account 
mentioned above, awkward and inconvenient. The vol¬ 
ume of the transactions which occur in the conduct of 
present-day business is so considerable, that causes and 
results, if treated in one account, necessitate extensive 
analysis in order that proper information may be obtained. 
It has been found advantageous to create during the fiscal 
period a series of accounts which are charged with all 
losses due to the parting with of values which have not been 
counteracted by the incoming of values possessing finan¬ 
cial weight. In other words, all expenses paid by the 
business are recorded in special accounts bearing a title 
indicative of their contents. At the end of the fiscal 
period, all these accounts, having served their purpose, 
which was to gather, analytically, facts of a similar nature, 
are closed into the Profit and Loss account by means of a 
credit to the individual accounts, and a debit to the 
Profit and Loss account for the aggregate amount. The 
same method is used for such gains as are indirectly con¬ 
nected with the operations of the period (such as interest 
on bank balances, cash discounts on purchases, etc., etc.). 
The Profit and Loss account is still directly debited and 
credited, during the fiscal period, with all such losses and 
gains as are not the result of the operations of the period 
(for instance, the loss of a customer’s account or the loss 


74 


THEORY AND TECHNIQUE OF ACCOUNTS 


of property through fire or other causes over which the 
business has no control), and with gross profits on mer¬ 
chandise. This last entry is made directly in the Profit 
and Loss account because the result which it shows is 
known only at the end of the period, after the application 
of the inventory. 

Rules for Double Entry 

Repeated attempts have been made to reduce the 
principles of double-entry bookkeeping to simple rules 
easily memorized and supposed to cover all possible business 
transactions; for instance: 

1. “Debit what comes into the business; credit 

what goes out of the business/’ 

2. “Whoever or whatever owes the business or firm 

is a debtor, and must be debited; whoever or 
whatever the business or firm owes is a cred¬ 
itor, and must be credited.” 

3. “The fundamental principle of double entry is 

that there must be a credit for every debit.” 

Irrespective of the fact that such formulas are apt to 
lead the reader towards the fatal belief that the mastery 
of double-entry bookkeeping is merely a matter of mem¬ 
orizing a simple rule, they are more than useless to the 
student of accounting. He does not understand them, 
and, consequently, is unable to apply them. Taking as 
an illustration rule 1, which is probably the least mislead¬ 
ing of the three, let us assume that $50 in cash has been 
received by the business in consideration of the indorse¬ 
ment by the proprietor of a promissory note executed by 
a person with whom he has had business dealings. How 
would the student apply the rule? He would, naturally, 
debit cash, because it is plain that cash has come into the 
business; but what would he credit? That which has 


DOUBLE ENTRY 


75 

really gone out of the business, admitting that the stu¬ 
dent is sufficiently advanced to reason that far, is precisely 
the one thing which he cannot credit, since it is a possible 
loss of equity in the assets in the form of a liability con¬ 
tingent upon the dishonor of the note at maturity. Would 
he see that the credit is to be given to the cause which 
brought about an increase in the asset “Cash” without neces¬ 
sitating the outgo of an equivalent amount of another 
financial value? 


Basic Differences Between Single and Double Entry 

The great advantage which double entry possesses 
over single entry, lies in the difference between the duties 
of the basic books used under both methods, i.e., the journal, 
and the ledger. 

The single-entry journal confines itself to the daily re¬ 
cording of facts, earmarking the transactions with persons 
in such a manner that they can be gathered in another 
book, the ledger, where their extent and their status may 
be readily determined. The single-entry ledger does not 
concern itself with the other factors of the proprietor’s 
wealth. It cannot be balanced, it cannot be closed, and 
as it usually does not take advantage of the analytical 
power of other books, it is practically of no help in the 
preparation of financial statements. 

The double-entry journal is not only a recorder, but 
an investigator, an analytical force always at work, 
which, as between debits and credits, weighs and classifies 
everything which is presented to it. If the occasion arises, 
the journal gives a name to, and appraises, the weights 
necessary to reestablish the equilibrium between the two 
main elements of a transaction. Having thus classified 
the facts, the journal passes them over to the ledger, 
which groups them with a view to the preparation of 


76 THEORY AND TECHNIQUE OF ACCOUNTS 

financial statements. Both the journal and the ledger can 
be balanced by themselves, thereby acting as a check one 
upon the other. 

Passing from Single Entry to Double Entry 

Passing from single entry to double entry should pre¬ 
sent no difficulty whatever to one who is familiar with 
the principles underlying these two systems of accounting. 

If the books used for single entry are to be retained 
under the new system, two journal entries are required 
in case the profit of the period has not been credited to 
the proprietor’s capital account. In the contrary case, 
one entry will be sufficient. If new books are to be 
opened, one entry will accomplish the change. To illus¬ 
trate, we will suppose that Charles Adams, whose books 
have been kept by single entry, desires to adopt the 
double-entry system, and assume: 

1- a. That the present books are to be retained. 

b. That Charles Adams’ capital account has 
not been credited with the profits of the 
period. 

2- a. That new books are to be opened. 

The procedure under the first assumption would be: 

1. Analyze the single-entry records, and obtain 

therefrom all possible information leading to 
the establishment of a statement of assets and 
liabilities similar to the model given in Chapter 
V; supplement the information thus obtained 
by any further step necessary to ascertain the 
exact status of the business at the date of the 
change of systems. 

2. Journalize the facts thus ascertained, in such a 

manner as to show: 


DOUBLE ENTRY 


77 


a. In the first entry: 

(1) All the assets shown by the statement of 

assets and liabilities, whether already on 
the ledger, or not. 

(2) All the liabilities, whether already on the 

ledger, or not. 

(3) The proprietor’s net investment as it stood 

at the beginning of the period. 

(4) The profit of the period, representing the 

amount by which the assets at the end 
of the period exceed the liabilities at the 
end of the period, plus the proprietor’s 
net investment at the beginning of the 
period. 

(5) Earmark by means of some appropriate sign, 

the assets and liabilities which are already 
in the ledger, and in the explanation of the 
entry refer to the fact that these items re¬ 
quire no posting. 

b. In the second entry: 

(1) The closing of the profit and loss balances 
to the debit or to the credit of the 
proprietor. 

If the net profit of the period has been credited to the 
proprietor before the passing from single to double entry, 
only one journal entry is required. In this case, the excess 
of assets over liabilities represents exactly the capital in¬ 
vested, as shown by the single-entry ledger. 


yg THEORY AND TECHNIQUE OF ACCOUNTS 

Example based on the first assumption: 

Journal of Charles Adams 


Ledger 

Folio Dr. Cr. 

i Land and Buildings...... $6,000.00 

3 Furniture and Fixtures as per appraisal.. 9 I 5 0 ° 

5 Horse, Wagon and Harness. 750 - 0 ° 

6 Merchandise Inventory (as per inventory 

book) . 3,4315.00 

7 Cash in bank and in office (as per bank 

certificate and physical count). 3,470.00 

10 Notes Receivable. 50.00 

13-30 Sundry Customers (as per list). 995.00* 

60 To First Bond and Mortgage Payable. $2,500.00 

62 Notes Payable. 2,000.00 

80-90 Sundry Creditors (as per list).... 1,800.00* 

95 Profit and Loss (as per analysis). 1,315.00 

100 Charles Adams, Capital. 8,000.00* 


To change the books of Charles Adams 
from single entry to double entry. The 
facts reflected above have been obtained 
from a statement of assets and liabili¬ 
ties, showing increases, decreases, and 
net capital increase, prepared as of De¬ 
cember 31, 1911, and now on file. 


95 Profit and Loss. $1,315.00 

100 To Charles Adams, Capital. $1,315.00 


To transfer to the capital account of the 
proprietor the net profit of the year 
ended December 31, 1911, as shown by 
the analysis of his books, records, and 
accounts, made in anticipation of the 
change from single entry to double 
entry. 

As to the facts which are already in the ledger and 
require no posting, they depend entirely upon the condi¬ 
tion of the single-entry books. The example given above 
presupposes that the books of Charles Adams complied 
with the rules of single entry, and carried only accounts 
with persons. 


* These items are already on the books, and require no posting. 













DOUBLE ENTRY 


79 


The procedure under the second assumption would be 
similar in every respect, the only difference being in the 
form of the journal entry, which might be as follows: 

Journal of Charles Adams 

Ledger 

Folio Dr. Cr. 

Pro Forma 

Charles Adams, sole trader, having aban¬ 
doned the single-entry system by which 
his books were kept up to this date, 
new books are to be opened. The fol¬ 
lowing entry is made to record the 
assets and the liabilities with which he 
begins business, as supported by an¬ 
alyses and other documents now on 
file, reference to which is hereby made. 


I Land and Buildings... $6,000.00 

3 Furniture and Fixtures as per appraisal.. 915.00 

5 Horse, Wagon and Harness. 750.00 

6 Merchandise Inventory (as per inventory 

book) .-. 3,435-00 

7 Cash in bank and in office (as per bank 

certificate and physical count). 3,470.00 

10 Notes Receivable. 50.00 

13-30 Sundry Customers (as per list). 995-00 

60 To First Bond and Mortgage Payable. $2,500.00 

62 Notes Payable. 2,000.00 

80-90 Sundry Creditors (as per list).... 1,800.00 

100 Charles Adams, Capital. 9,315.00 


In regard to the sundry customers and creditors, they 
would be stated individually, and posted from the journal 
or stated as shown above and posted from the list. 










CHAPTER VII 


ACCOUNTING SYSTEMS—TRIPLE AND QUAD¬ 
RUPLE ENTRY 


Logismography 

The respect which the accountants of continental 
Europe have for the journal, may or may not be due to the 
stringent requirements of fiscal laws; whatever its cause, 
it has greatly complicated the application of bookkeeping 
to modern conditions. In 1869, the enactment of the 
Italian law making compulsory the adoption of double¬ 
entry bookkeeping by the Italian government, found the 
native accountants fretting under what they called the 
lack of elasticity of the new system. In 1872, the chief 
accountant of the War Department of Italy, Giuseppe Cer- 
boni, introduced a new system of bookkeeping, which he 
called Logismography; that is to say, the logical expres¬ 
sion of bookkeeping facts. 

Cerboni enunciated what is known in Europe as “The 
Cerbonian Doctrine,” generally referred to in English- 
speaking countries as “the personalistic theory of ac¬ 
counts.” He claimed that it was inadmissible that the 
proprietor should be debited with his assets, i.e., charged 
with what he owns, and credited with his liabilities, and 
further credited with the excess of his assets over his lia¬ 
bilities. He advanced the theory that the business repre¬ 
sents the aggregate of the persons who are intrusted with 
the wealth of the proprietor, or who have intrusted the 
proprietor with part of their wealth. Hence, instead of 
debiting and crediting accounts, he suggested debits and 

80 


TRIPLE AND QUADRUPLE ENTRY 


8l 


credits to the cashier, the storekeeper, the manager of the 
building, the mortgagee, the banker, etc., etc. This led 
to the division of the general ledger into three parts, as 
follows: 

1. Containing accounts of the proprietor, with each 

one of the values invested by him in the busi¬ 
ness, and with each one of the values which he 
owed. 

2. Containing accounts with the persons who held 

the values invested by the proprietor in the 
business, or who held claims against him. 

3. Containing accounts showing the causes for the 

fluctuations reflected by the values contained 
in Part I. 

It will be seen from the foregoing that in some in¬ 
stances, triple and quadruple entries had to be resorted to. 
For instance: 

A building costing $5,000 is destroyed by fire. The 
journal entries might be as follows: 

Ledger I 

Proprietor . $5,000.00 

To Building. $5,000.00 

Ledger II 

To John Doe, Keeper of 

Building . $5,000.00 

Ledger III 

Losses due to fire. $5,000.00 

As a result of this complicated system, the facts ob¬ 
tainable at the end of the period in regard to the loss by 
fire were: 

1. The capital of the proprietor had been reduced 
by $5,000, through the destruction of the 
building. 






82 THEORY AND TECHNIQUE OF ACCOUNTS 


2. John Doe was discharged from his liability to the 

proprietor in so far as the value of the building 
intrusted to him was concerned. 

3. The cause for the impairment of the proprietor’s 

capital was a fire. 

The same facts could be obtained by double entry, in 
a much simpler way, and the system was abandoned by 
the Italian government at the death of its inventor. 

Statmography 

This system, which was invented by Emanuele Pisani, 
a professor at the High School of Commerce of Bari, Italy, 
has for its object, in the words of Pisani himself, to keep 
books “through the medium of double, triple, and quad¬ 
ruple balances.” The system is supposed to be ideally 
adapted to the needs of governments, municipalities, and 
all industries managed by representatives of the people for 
the good of the people. It attempts to differentiate and 
harmonize three classes of facts: 

1. The “dynamic” facts, which consist of the incom¬ 

ing and outgoing transactions of the account¬ 
ing period. 

2. The “statical” facts, which might be called the 

“status quo” of the business at the beginning 
of the period, as influenced by losses which 
have no connection with the operations of the 
business and are due to acts of God, or to mis¬ 
management of employees, etc. 

3. The “statico-dynamic” facts, which are nothing 

more than the causes which have brought 
about the increases and decreases of assets and 
liabilities. 

It does not appear that statmography has as yet in¬ 
duced European municipalities or government banks to 


TRIPLE AND QUADRUPLE ENTRY 


83 


abandon the older system of double entry, but it must be 
said that it has greatly influenced the terminology of their 
financial statements. 

The subject of the quadruple-entry system has been in¬ 
troduced in this book, because it serves to emphasize the 
fact that the great aim of accounting the world over is 
so to analyze financial transactions that they will not only 
measure the extent of the success or of the failure of the 
business venture, but also to classify the causes and pre¬ 
sent them logically in order that they may give adminis¬ 
trative information, and make them express in their own 
way the history of every department of the organization. 


CHAPTER VIII 


THE FINANCIAL BOOKS—THE JOURNALS 

The books which are necessary in order that accounts 
may be kept successfully, are: 

1. The Journal 

2. The Ledger 

The Journal 

The original journal was not a book of first record. 
The transactions were entered, as they occurred, in a 
species of narrative book, “la prima nota,” or preliminary 
record, the only claim of which was to be thorough and 
chronological. From this “prima nota ” which might be 
called “the blotter” or “day book,” the transactions were 
transferred to the journal in such a manner as to gather as 
far as possible the facts of homogeneous nature. 

The journal originally contained only one column, the 
debits and credits being earmarked, close to the column, 
by means of the contractions Dr. (Debtor) and Cr. 
(Creditor). In 1796, John of Bristol advocated the use 
of two journal columns, one for debits and one for credits. 
This gave to the journal its present form: 


Date Accounts and Explanations 
1912 


Posting 

Reference Dr. Cr. 


Jan. 1 Promissory Notes Receivable_ 

To John Dorman. 

For settlement by note (dated 


15 $150.00 

75 


$150.00 


1/1/12, due 3/1/12, indorsed 
by V. Curtis) of his account 
current. 


84 






THE JOURNALS 


85 

The addition of the second column had the advantage 
of minimizing the possibility of error, since it made the 
book capable of being brought to a balance showing that 
the debits equalled the credits. 

With the possible exception of certain economic types 
of organization where the tremendous mass of detail to be 
handled, and the multiplicity of its sources, make its reten¬ 
tion by the auditor a matter of convenience, the journal 
in its original form is a thing of the past. One after an¬ 
other, its component parts have been detached and built 
up into separate journals bearing titles which, to the lay¬ 
man, do not even suggest the common origin of the 
books. The journal, as such, is still intrusted with the 
recording of opening entries, correcting or adjusting en¬ 
tries, and closing entries. This, interpreted in the light of 
what has been said in connection with double entry, means 
that the functions of the present-day journal are to estab¬ 
lish the original equilibrium; to harmonize such dis¬ 
crepancies as occur during the fiscal period through the* 
erroneous recording of transactions; and, at the end of the 
fiscal period, to gather all nominal accounts to be closed 
into the Profit and Loss account, to close them, and, in 
turn, to close the Profit and Loss account to the debit or 
credit of the proprietor, or of an account representing un¬ 
drawn or undistributed profits. 

The Sub-Journals 

The several steps taken in the segregation of the 
journal accounts have theoretically been as follows: 

1. The removal of all cash transactions 

2. The removal of all transactions referring to mer¬ 

chandise 

3. The removal of all personal transactions not in¬ 

cluded in 1 and 2 


86 THEORY AND TECHNIQUE OF ACCOUNTS 


1. The removal of all cash transactions from the 
journal has eliminated: 

a. The payments to creditors, involving discounts, 

allowances and rebates, and, in some instances, 
return of goods. 

b. The payments to customers in the form of refunds. 

c. Receipts from customers, involving discounts, 

allowances and rebates, and, in some instances, 
return of goods. 

d. Receipts from creditors in the form of refunds. 

e. Payments for expenses of conducting the busi¬ 

ness, expenses incidental to the receipt or ship¬ 
ment of merchandise, payments for services 
rendered, etc. 

f. The receipts of borrowed money, the proceeds of 

the sale of assets, or of the discounting of 
promissory notes, etc., etc. 

g. The disbursements incident to the liquidation of 

liabilities incurred through loans, etc., to the 
dishonor of discounted paper, to the with¬ 
drawal of funds by the proprietor, etc., etc. 

2. The removal of all merchandise transactions from 
the journal has eliminated: 

a. Purchases, and returns of part thereof by the pro¬ 

prietor. 

b. Sales, and returns of part thereof to the proprietor. 

3. The removal of personal transactions from the 
journal has eliminated: 

a. The receipt, or issuance, of promissory notes, 
drafts receivable or payable, and other commer¬ 
cial paper; and, generally, the recording of all 


THE JOURNALS 


87 

other transactions not covered by the fore¬ 
going. 

The dissociated components of the original journal 
have been built up into a complete system of journals af¬ 
fording a limitless distribution of work, besides giving 
without effort a complete classification of transactions. 
Thus we have: 

1. The cash journal (cash book) itself, divided into 

two parts, one for the debits to cash and 
credits to other accounts; the other for 
credits to cash and debits to other accounts. 

2. The merchandise journal, divided into as many 

subdivisions as the business comports; for in¬ 
stance: 

a. Purchase Journal 

b. Sales Journal 

c. Returned Purchases 

d. Returned Sales 

3. The promissory notes journal, divided into two 

parts: 

a. Notes Receivable 

b. Notes Payable 

4. The general journal, in which are recorded all 

transactions which cannot find expression in 
the other journals. 

The “Modern Recording Media” in the following dia¬ 
gram are generally known to accountants as “books of 
original entry,” that is to say, books in which transac¬ 
tions pertaining to the subject matter indicated by the 
title of the book are entered as they occur. These books 
are, as a rule, supposed to be used periodically as posting 

media. 


88 THEORY AND TECHNIQUE OF ACCOUNTS 


Component Parts 

Modern 

Contents of Modern 

of 

Recording 

Media (Method 

Original Journal 

Media 

of Handling) 

Opening Entries: 



Assets 

Liabilities 

Proprietor’s Net .Invest¬ 
ment 

General 

Journal 

Dr. Assets 

j Liabilities 
^ r ‘ l Proprietor 

Merchandise Transactions: 

Purchase 

Dr. Merchandise 

Purchases 

Journal 

Cr. Creditors 

Sales 

Sales 

Dr. Customers 


Journal 

Cr. Merchandise 

Returned Purchases 

Returned 

Dr. Creditors 


Purchase 

Journal 

Cr. Merchandise 

Returned Sales 

Returned 

Dr. Merchandise 


Sales 

Journal 

Cr. Customers 

Cash Transactions: 


Debit Side: 

Receipts from Customers 


Dr. 

Receipts from Creditors 


Net Cash 

(refunds) 


( Allowances 

Receipts from all other 


* Discounts 

sources 


( Rebates 



Cr. 

Incidental Transactions: 


Customers 

Discounts ) 

a rp 

Allowances v 0 

Rebates ) Customers 

Cash 

Journal, 

Creditors (refunds) 

Other Ledger Accounts* 

Other Discounts 

divided 

Credit Side: 

Disbursements to Credi- 

into two 
sections 

Cr. 

Net Cash 

tors 

Disbursements to Cus¬ 
tomers (refunds) 
Disbursements for all 


( Discounts 
* J Rebates 
( Allowances 

other causes 


Dr. 

Creditors 

Customers (refunds) 
Other Ledger Accounts* 

Incidental Transactions: 
Discounts ) 

Allowances (• ron ? 
Rebates \ Creators 



* Subject to monthly analysis and detail posting therefrom. 
















THE JOURNALS 


89 


Component Parts 

of 

Original Journal 

Modern 

Recording 

Media 

Contents of Modern 
Media (Method 
of Handling) 

Transactions with Persons 
Not Included Above: 
Notes and Bills Receiv¬ 
able and Payable 

Notes and 
Bills 

Receivable 

and 

Payable 
Journal, 
in two 
sections 

First Part: 

Dr. Notes and Bills Re¬ 
ceivable 

Cr. Customers 

Second Part: 

Cr. Notes and Bills Pay¬ 
able 

Dr. Creditors 

Correcting Entries 

General 

Journal 

Dr. Account over-cred¬ 
ited 

Cr. Account under-cred¬ 
ited 

Closing Entries 

General 

Journal 

Close all the accounts 
which are raised during the 
accounting period to reflect 
the causes for increases and 
decreases of invested values, 
by crediting individually the 
accounts showing debit bal¬ 
ances and debiting Profit 
and Loss with the aggregate 
amount; reverse the proce¬ 
dure for accounts showing 
credit balances. Close Profit 
and Loss by debiting it with 
the net gain and crediting 
proprietorship. If the re¬ 
sult of operations is a loss, 
credit Profit and Loss and 
debit proprietorship. 


The dissecting of the original journal into its component 
parts, may or may not have been accomplished as a direct 
result of the organization of business into departments. 
Still, the necessity of adapting the financial accounting 















90 


THEORY AND TECHNIQUE OF ACCOUNTS 


records to the needs of the various operating branches of 
the administration, and to the ever-increasing demands 
of executives for multiple, accurate, and readily obtain¬ 
able information, must have been felt keenly by the count¬ 
ing house, if we are to base our judgment upon the quan¬ 
tity, and the analytical construction of the records which 
it has evolved and placed at the disposal of the various 
departments. 

Purchasing Department—Purchase Journal 

Irrespective of the extent of its own activities, which 
it must know at all events, the purchasing department, 
being the purveyor of the factory as well as of the other 
departments (such as shipping, selling, and administra¬ 
tive), must supply the accounting division with its quota 
of the facts necessary to ascertain the cost of operations. 
The information required may extend not only to the de¬ 
partments for whose account the purchases are made, but, 
as well, to the classes of goods bought; whatever it may 
be, the purchasing department finds in the purchase jour¬ 
nal an adaptable and efficient helper, as will be seen by 
reference to the accompanying Figures io and n. 

In connection with the purchase journal, there may 
be kept, if occasion demands, a “returned” purchase 
journal built up on precisely the same lines as the pur¬ 
chase journal. If the returns are few, a section of the 
purchase journal may be assigned to them; if they are in¬ 
significant, they might be recorded by the accounting 
division in the general journal from data supplied by the 
purchasing department. 

Sales Department—Sales Journal 

The sales department, outside of the data which it 
must furnish to the accounting division, may be vitally 
interested in: 


PURCHASE. JOURNAL 

- MANUFACTURING MATERIALS & SUPPLIES. 


THE JOURNALS 


91 



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g 2 THEORY AND TECHNIQUE OF ACCOUNTS 


purchase: journal 

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Figure n. Purchase Journal 




















































































THE JOURNALS 


93 


1. Statistics of sales by communities 

2. Statistics of sales by salesman and district, as 

distinguished from sales made by the home 
office 

Figures 12 and 13 illustrate the adaptability of the 
journal to the requirements of the sales department. 
The remarks concerning “purchases returned” under the 
discussion of the purchase journal, apply as well to sales 
returned. 

Treasurer’s Department—Cash Journal 

The primitive cash book was nothing more than a 
memorandum account with cash, in which the receipts 
appeared on the left and the disbursements on the right. 
From time to time the transactions were analyzed and 
recorded in the journal. The disadvantage of the book 
lay, not only in the duplication of work which it neces¬ 
sitated, but, as well, in the cross entries which had to be 


made under certain not uncommon conditions, such, for 
instance, as a cash settlement involving the giving or taking 
of a cash discount. 

To illustrate: Customer A, whose indebtedness amounted 
to, say, $200, remitted within ten days, and taking advantage 
of the cash discount, sent $196. The entries were made as 
follows: 


Cash Book 


Dr. 

Name and 


Cr. 

Name and 


Date Explanation Amt. 
1914 

Feb. 1 Customer A (bill of 


Date Explanation 
1914 

Feb. 1 Customer A (dis- 


Amt 


Jan. 25, 1914).$200.00 


count on bill, Jan. 
25 , 1914 ). 


$4.00 






94 


THEORY AND TECHNIQUE OF ACCOUNTS 



Figure 12. Sales Journal 

The letters appearing in the distribution columns represent classes of merchandise. 














































































THE JOURNALS 


95 


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Figure 13. Sales Journal 

The letters appearing in the distribution columns refer to individual salesmen. 









































































































THEORY AND TECHNIQUE OF ACCOUNTS 


Journal 

Names and Explanations Dr. Cr. 

Feb. i, 1914 

Cash . $200.00 

To Customer A. $200.00 

For settlement in cash of our bill of Jan. 25, 1914, 
subject to a cash discount of 2% for 10 days. 

Discount. $4.00 

To Cash. $4.00 


For discount of 2% on $200.00 to Customer A on 
our bill of Jan. 25, 1914. 

The foregoing method of handling the cash book was 
open to the objection that it did not show the actual cash 
transactions as they occurred, and that it rendered the 
audit of the cashier’s accounts very lengthy and compli¬ 
cated. This objection, serious as it may have been, was 
as nothing to the defects developed by the books so kept 
when, having evolved with the business, the cashier be¬ 
came treasurer, that is to say, when the clerk of the shop 
became an officer of the now highly organized body 
economic. The treasurer needed information of the most 
varied nature, and he had to make his records reflect it. 
He quickly realized that if the receiving and disbursing 
of cash gave rise to deductions from the face of the 
amounts to be received and paid out (in the form of dis¬ 
counts, allowances for claims, returns of goods sold or 
purchased, etc.), it was possible to transform the cash 
book into a cash journal which would not only record 
accurately the status of the asset “Cash,” as affected by 
the transactions of the period, but indicate as well the 
accounts which were to be debited (or credited) and main¬ 
tain equilibrium between cash and the accounts which 
were to be credited (or debited) as a result of the cash 
transactions. 

Accordingly, he built up the cash journal (Figures 14, 
15), which provides on one side of the page, columns for 






CASH JOURNAL-DEBIT SIDE 

(IN CASH BOOK) 


THE JOURNALS 


97 



% 


Figure 14. Cash Journal (debit side) 






















































































gS THEORY AND TECHNIQUE OF ACCOUNTS 


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Figure 15. Ca^/x Journal (credit side) 






























































































THE JOURNALS 


99 


accounts to be debited and accounts to be credited; and 
on the other side, columns for accounts to be credited, 
and accounts to be debited. This journal, like all others, 
is capable of limitless extensions to suit particular cases. 

Petty Cash Book 

When used by the cashier as a memorandum of petty 
disbursements, the petty cash book has no particular 
anatomy. All it is intended to do is to record faithfully 
the cash transactions which, while small in amount, occur 
so frequently as to make their daily posting a matter of 
inconvenience. The disbursements may be recorded in 
the petty cash book in any way which is deemed satis¬ 
factory. Monthly or oftener, an analysis is made which 
forms the basis of an entry (properly supported by 
vouchers) to appear in the general cash journal. 

When used in connection with all disbursements made 
otherwise than by check, the petty cash book may be¬ 
come a journal in the true sense of the word and be used 
as a posting medium, in so far at least as the disburse¬ 
ments are concerned. It is, in this case, nothing more 
than a portion of the general cash journal assigned to dis¬ 
bursements for petty expenses. 

Under the “imprest fund” system of providing for 
petty cash disbursements (of which we will speak later) a 
book such as shown in Figure 16 could be used to advan¬ 
tage; it would not, however, be treated as a posting 
medium, but as an analytical record from which the re¬ 
quired data could be readily obtained. 

Notes and Bills Journal 

With the possible exception of the pay-roll book, 
which is discussed later, the recorder of the notes and 
bills receivable and payable is probably the book of orig- 


i 


IO o THEORY AND TECHNIQUE OF ACCOUNTS 


PETTY CASH JOURNAL 
(IN petty cash book) 

DISBURSEMENTS* 

Distribution 

Other Accounts 

Amount 1 







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Figure 16. Petty Cash Journal 





























































































NOTES AND BILLS JOURNAL 

NOTES AND BILLS RECEIVABLE SECTION 


THE JOURNALS 


IOI 





Figure iy. Notes and Bills Journal (receivable section) 




































































































102 THEORY AND TECHNIQUE OF ACCOUNTS 








Figure 18. Notes and Bills Journal (payable section) 













































































THE JOURNALS 


I0 3 

inal entry which suggests in the least degree the idea of 
the journal. This may be due to the facts: first, that a 
great deal of the information which it contains is purely 
statistical, and in no way related to journalizing; second, 
that the data concerning the disposition of the notes 
prior to, or at, the time of their maturity, are also re¬ 
flected by the cash journal and posted therefrom; third, 
that, generally speaking, bookkeepers use the book 
merely as a memorandum which gives the facts necessary 
for the monthly recording in the general journal of the 
transactions in promissory notes. Still, irrespective of 
the great value which it derives from the thorough char¬ 
acter of the information which it is capable of giving, the 
notes and bills journal, when properly constructed, con¬ 
stitutes an excellent posting medium for transactions in¬ 
volving the receipt or issue of promissory notes. 

It will be seen from Figures 17, 18 that the notes and 
bills book is essentially a journal, since under the heading 
“Amount” it provides: 

1. In the Notes and Bills Receivable section, for: 

Debits to: 

a. “Notes and Bills Receivable” (asset ac¬ 
count) 

Credits to: 

a. Customers who have executed or assigned 

the notes 

b. The interest carried by the notes, and 

added to the amount of principal 
which settles for the customers’ in¬ 
debtedness 

c. Other ledger accounts which might be 

affected by the incoming of a promis¬ 
sory note 


X04 THEORY AND TECHNIQUE OF ACCOUNTS 

2. In the Notes and Bills Payable section, for: 

Credits to: 

a. “Notes and Bills Payable” (liability ac¬ 
count) 

Debits to: 

a. Creditors in whose favor the notes are 

executed 

b. The interest (if any) carried by the note 

on its face 

c. Other ledger accounts which might be 

affected by the outgoing of a promis¬ 
sory note 


Pay Roll Journal 

In its simplest form, and when used by concerns which 
do not keep their books on the accrued basis, and whose 
organization is not departmentalized, the pay-roll book 
can hardly be said to be a journal, since it merely states 
the names of the employees, and the amounts earned by 
them during a given period. (See Figure 19.) 

In such cases as the above, the book is merely a mem¬ 
orandum record, gathering weekly or monthly, the de¬ 
tails which will support the entries appearing in the cash 
journal to the credit of cash and to the debit of office 
salaries, or such other accounts as are indicated by the 
analysis of the pay-roll book in so far as official capacity 
is concerned. 

When, however, departmental organization exists 
and when, besides, the accrued liabilities (or assets) are 
placed on the books at the end of each weekly or monthly 
division of the accounting period, the pay-roll book may 
be developed into an invaluable book of original entry. 
(See Figure 20.) 


ROLL JOURNAL 


THE JOURNALS 


/ 


105 



Figure 19. Pay-Roll Journal—Simple Form 
































































































I0 6 theory and technique of accounts 



Figure 20. Pay-Roll Journal 
























































































THE JOURNALS 



107 


Figure 21. Pay-RoU Journal—Departmental 




















































































io 8 theory and technique of accounts 



Figure 22. Special Column Journal 






























































































































THE JOURNALS 


109 


The pay-roll journal shown in Figure 20 is designed 
for a warehouse. During certain seasons, certain depart¬ 
ments are very active, while others are slack; the men of 
one department may be put to work in other depart¬ 
ments. This necessitates the distribution columns, which 
are so headed as to show the ledger account to which the 
total of the items appearing therein, will have to be 
debited. 

The adaptability of the pay-roll journal to the require¬ 
ments of the treasurer’s department, is illustrated by 
Figure 21. The form is supposed to be “loose-leaf” and 
used by concerns which find it convenient to have the em¬ 
ployees paid in the department in which they work. 

Specially Ruled Journals 

One sometimes finds, in certain businesses, journals 
providing on either side of the space allotted to the ex¬ 
planations of the entries, special debit and credit columns 
in which are entered the names of the active accounts, 
one column being reserved for inactive ledger accounts. 
These books are sometimes referred to as day-book 
journals, because they unite in a single book, the original 
blotter, that is to say, the chronological and historical 
records, and all the components of the original journal in 
which the data of the blotter used to be classified. 


CHAPTER IX 


THE FINANCIAL BOOKS—THE LEDGER AND 

VOUCHER RECORD 

The Structure of the Ledger 

The ledger has been aptly called by the Italians 
“Libro Maestro.” It is, indeed, the master book, or the 
book of the master of the business; the proprietor should 
be able to find in it the synthetic grouping of the analytic 
labor of the journal. 

We have referred to the journal as “the scales” in 
which the transactions are weighed and classified as be¬ 
tween debits and credits. We might compare the ledger 
to a chest of drawers, each unit of which is divided into 
two vertical sections, the left being known as the debit 
side, and the right, as the credit side. Each drawer is 
given a name indicative of the subject matter which will 
be placed therein as soon as the iournal has classified the 
transactions. 

In order that information concerning the contents of 
each drawer may be readily obtained, each side of it is 
subdivided into four compartments of unequal dimen¬ 
sions, intended to contain: 

1. The date of the transaction 

2. The explanation or name of the value which the 

journal has classified as the counterpart of the 
one to be placed in the particular drawer in 
question 


no 



THE LEDGER AND VOUCHER RECORD 


III 


3. The particular journal scales which attended to 

the weighing of the transaction as a whole 

4. The money value of every item 

Thus we have the ledger account form which usage 
has consecrated: 


Name of Account* 




Dr. 






Cr. 




Date 

Explanation 

Refer¬ 

ence 

Amt. 

Date 

Explanation 

Refer¬ 

ence 

Amt. 



■ 











Variations of the Standard Ledger 

Every book of accounts which is built upon lines 
similar to the ruling given above for the ledger account, 
is said to be “ledger-ruled.” 

A slight alteration of the conventional frame has been 
made in what is generally known as “The Boston 
Ledger,” and, less commonly, as “The Bank Ledger.” 
This book is the result of the demand of certain types of 
financial organization for daily balances; it places the 
credit column alongside of the debit column, and intro¬ 
duces a third column for balances. The accounts are 
arranged, according to individual preference, one, two, or 
four to the page. An example is given in Figure 23. 


* In practice, the headings appearing 


in the columns are omitted. 

































112 


THEORY AND TECHNIQUE OF ACCOUNTS 



Figure 23. Boston Ledger 


























































THE LEDGER AND VOUCHER RECORD 


113 



Figure 24. Boston Ledger—Special Form (master sheet) 




























































































X!4 THEORY AND TECHNIQUE OF ACCOUNTS 

Storage warehouses, dairies, real estate agencies, and 
other businesses whose clients and patrons are many, but 
in which the monthly transactions are comparatively few, 



have developed the Boston ledger to such an extent that, 
if an error occurs in the posting, it will be located at once 
by comparing the footings of the ledger columns with 































































































THE LEDGER AND VOUCHER RECORD 


115 

those of the corresponding columns of the specially ruled 
journal. The ledger so developed (Figures 24, 25) is a 
loose-leaf book, composed of long sheets and short sheets, 
containing, according to the importance of the accounts to 
be carried, one, three, five, ten, or twenty accounts to the 
page. 

The long sheets are used as form sheets and contain 
the number of the customer or client, his name and ad¬ 
dress, and the headings of the different spaces and 
columns. The short sheets are six in number for every 
long sheet and contain neither names nor headings. One 
side of each sheet is used for one month. Each sheet be¬ 
gins with the initial balance for the month, and ends with 
the closing balance for that month, the debit and credit 
transactions being given as many columns as there are 
possible classes of charges or credits. Each account can 
be added monthly, both horizontally and vertically. The 
footings of each column of each and every one of the 
three, five, ten, or twenty accounts which the page con¬ 
tains, are added at the end of the page, and reflected 
monthly by a special recapitulation sheet, the totals of 
which must agree, by columns, with the footings of the 
corresponding columns of the books of original entry. 

The great advantages claimed for the book are: 

1. It permits of monthly customers’ statements be¬ 

ing made by the bookkeepers without refer¬ 
ence to books of original entry. 

2. If the customers ledgers do not agree with the 

controlling account in the general ledger, the 
differences can be traced at once to the par¬ 
ticular column where they originated, by com¬ 
paring the results of the sundry columns of the 
customers ledgers with the sundry columns of 
the books of original entry. 


IX 6 THEORY AND TECHNIQUE OF ACCOUNTS 


3. In connection with the current ledger, there is 
kept a “transfer ledger” which, being provided 
with duplicate long sheets, keeps in any single 
book, for as many years as may be required, 
the monthly history of all the transactions 
with all customers. 

Private Ledger 

If the business is of such a nature as to make it advis¬ 
able to prevent the employees from obtaining connected 
information concerning its various phases, the general 
ledger is relieved of all the facts which it is desired to keep 
secret. The vital data are kept in a private ledger which 
is posted by the head of the concern, the auditor, or a 
confidential clerk, from the results of the books of original 
entry. The book is placed in equilibrium by adding to 
the accounts, with such values as it contains, an account 
known as “General Ledger” which is debited (or 
credited) with the net of the values recorded by the latter 
book. Equilibrium is maintained by debiting or crediting 
the General Ledger account with the net of the fluctua¬ 
tions of the values which it contains. 

If the facts to be kept secret relate to profits, it is 
likely that the books of original entry will be made as 
little analytical as possible. It is also probable that 
analyses will be made by the keeper of the private ledger, 
and their results entered in a private journal. 

In what is left of the general ledger, there is kept an 
account with the private book, which is debited with the 
same amount with which the private ledger credits the 
general ledger, and vice versa. The following illustration 
will show the operation of the private ledger and the rela¬ 
tion of that book to the general ledger. This is especially 
exemplified by the presentation of the general ledger ac¬ 
counts as they would appear if no private ledger were kept. 




THE LEDGER AND VOUCHER RECORD 


Private Ledger of A. B. C. Partners 
Trial Balance 

(After closing) 


Plant & Equipment.... 

$20,000.00 

* 

Capital—A . 


Furniture & Fixtures.. 

3,000.00 

Capital—B. 


Drawings—C . 

4,500.00 

Capital—C . 


Special Deposits. 

10,000.00 

Undivided Profits.... 


Patents. 

20,000.00 



Investments. 

8,000.00 



General Ledger. 

15,500.00 




$81,000.00 


$81,000.00 


General Ledger of A. B. C. Partners 
Trial Balance 

(After closing) 


Cash & Petty Cash... $ 

7,100.00 

Mortgage Payable. 

$ 7,000.00 

Inventory of Mdse. 

10,000.00 

Accounts Payable. 

23,680.00 

Customers. 

34,680.00 

(Individual accounts 


(Individual accounts 


kept in creditors 


kept in customers 


ledger) 


ledger) 


Notes Payable. 

5,000.00 



Wages Payable. 

600.00 



Private Ledger. 

15,500.00 

$51,780.00 

$51,780.00 


General Ledger of A. B. C. Partners* 
Trial Balance 

(After closing) 


Cash & Petty Cash-$ 7,100.00 

Plant & Equipment- 20,000.00 

Furniture & Fixtures.. 3,000.00 

Inventory of Mdse. 10,000.00 

Customers. 34,680.00 

Drawings—C . 4,500.00 

Special Deposits. 10,000.00 

Patents. 20,000.00 

Investments. 8,000.00 

Capital—A .$ 15,000.00 

Capital—B. 16,000.00 

Capital—C . 22,000.00 

Mortgage Payable. 7,000.00 

Accounts Payable. 23,680.00 

Notes Payable. 5,000.00 

Wages Payable. 600.00 

Undivided Profits. 28,000.00 

$117,280.00 

$117,280.00 


* On the assumption that there is no private ledger. 



























































IX 8 THEORY AND TECHNIQUE OF ACCOUNTS 

Voucher Record 

Originally a columnar purchase journal, this book has 
been so altered and extended, that it is not uncommon to 
hear accountants refer to it as a combination of the pur¬ 
chase journal and creditors ledger. 

If we decline to give the name “ledger” to any rec¬ 
ord other than the time-honored book bearing that title, 
it may still be admitted that the voucher record seems to 
combine two books. It is, in fact, generally true that 
where it is used, no creditors ledger, as such, is kept. 

Upon close examination of the mechanism of the 
voucher record, we find that it differs from the analytical 
purchase journal only in that it provides for the recording 
of the amount paid to the creditors and, in some cases, for 
the discounts gained at settlement. Investigating fur¬ 
ther, we find that the forms usually submitted by writers 
and by practising accountants fail to support the claims 
made for them, since they do not provide for returns, 
allowances, and other deductions which are likely to be 
made on the face of a bill at settlement. Nor do they pro¬ 
vide for settlement by promissory notes, to say nothing 
of the many other complications which may arise. We 
must realize then that, in connection with the voucher 
record, there must be kept memoranda in some form 
whereby the status of the account of each creditor may 
be readily ascertained. Whether such memoranda are 
kept on cards or on ordinary pieces of paper systemati¬ 
cally filed, or whether they are kept in a bound book or 
loose-leaf book, is as immaterial as the name which is 
given to them or to the file which contains them. No 
matter what the system adopted may be, it is to all in¬ 
tents and purposes a ledger. The name ledger could be 
given to a vertical file; as a matter of fact, nothing comes 
so near to being an ideal ledger as the card files kept by 
life insurance companies in connection with the premiums 






THE LEDGER AND VOUCHER RECORD 


119 



Figure 26. Voucher Record 
















































































































































































































120 theory and technique of accounts 

collected, overdue, collectable, and uncollectable under 
the policies which they have issued. 

The most elaborate voucher record which ingenuity 
could devise, would fail as utterly as a creditors ledger, as 
did the original journal. In this latter book there can be 
found, if one were tempted to look for them, all the names 
of the creditors of the business, together with the amount 
of the indebtedness towards them which each individual 
transaction brought about, and the exact detail of the 
settlements made with them. But it was precisely be¬ 
cause no one would ever have time or patience to analyze 
the record in order to find the true status of any given 
creditor, that the creditors ledger came into existence. 

The voucher record is a very useful book, in that it 
discloses the amount of vouchers payable which were re¬ 
ceived from all sources during the month and provides for 
the distribution of that amount, whether to the classes 
of materials purchased, or to the individual accounts 
raised to analyze the expenses of the period; it can even 
be made to reflect the true status of that liability at any 
time during the accounting period, as well as the sundry 
steps which have been taken to incur it and to reduce it. 
The book is undoubtedly the highest expression of that 
power of analysis with which books of original entry have 
been credited. But there is a limit to its usefulness, and 
to claim more for it than it can do, is to mislead the 
student of accounting and the business man. 


CHAPTER X 


THE TECHNIQUE OF POSTING 

Functions of the Ledger 

Under the word “Post” the Encyclopaedic Dictionary 
gives the following: “Bookkeeping: (i) To carry or 
transfer (as items, accounts) from a journal to a ledger. (2) 
To make the necessary or proper entries in: as, To post 
one’s books.” And under the word “postil” it says: “An 
explanatory or marginal note * * * especially one written 
in a margin; a commentary.” 

The above definitions show that items appearing in a 
journal (or book of original entry) must be carried to 
proper accounts in the ledger, sufficient marginal notes, 
or commentaries, being made in order to render the entry 
self-explanatory. From what has been said in the fore¬ 
going chapter in connection with the ledger account 
frame, it seems that the proper place for these marginal 
notes, or commentaries, is the space allotted to the date, 
the explanation, and the reference to the journal and 
journal folio from which the entry comes. 

If the ledger is used with due respect for the purpose 
for which it was created, each individual account affords 
invaluable information in regard to: 

1. The particular value referred to by the name 

2. The positive and negative (Dr. and Cr.) fluctua¬ 

tions of the value 

3. The counterpart of every side of the value and of 

every item on each side, and, in certain cases— 


121 


I2 2 theory and technique of accounts 

4, The causes which have brought about the in¬ 
creases and the decreases 

If, however, the information which the frame of the 
account provides for, is omitted or is carelessly stated, 
the ledger loses its value, and becomes a mere index of 
the monetary importance of transactions, and of their 
location in books of original entry. 

Rules for Posting 

The rules which accountants would like adopted in 
regard to ledger explanations are as follows: 

1. When debiting or crediting an account, give in 

the space allotted to explanations the name of 
the account which is credited or debited as a 
result of the transaction. 

2. When debiting or crediting an account with an 

amount representing credits or debits to sev¬ 
eral accounts, insert the word “Sundry” in the 
place reserved for explanations. 

3. Refer clearly to the journal from which the entry 

comes. 

The meaning of a ledger account kept in accordance 
with the above rules, is readily understood by the layman, 
and in a great many cases the surface information which 
the book affords will be quite sufficient to satisfy the re¬ 
quirements of the proprietor of the business. The only ac¬ 
counts which he needs to investigate further, if detail is 
required, are the ones containing the explanation “Sun¬ 
dry.” If, on the other hand, the ledger shows amounts 
only, or abbreviated explanations which only the book¬ 
keeper can understand; it is of no value to the proprietor. 
Bookkeepers are generally interested only in methods and 
devices which save them personal effort; they are apt to 
forget that they were not engaged to make their work 


THE TECHNIQUE OF POSTING 


123 

easy, but to keep books in such a manner as to make them 
valuable to the employer. 

In this connection, it must be said that bookkeepers 
who do not respect well-established principles of book¬ 
keeping because they are personally unable to see the 
basis on which they rest, have robbed the double-entry 
method of a great deal which was valuable, and are re¬ 
sponsible for the lack of illuminative information which so 
many modern books reveal upon close investigation. 


CHAPTER XI 


CONTROLLING ACCOUNTS 

General and Subsidiary Ledgers 

Inasmuch as the establishment of ledger controls has 
resulted from the evolution of the journal, and for the 
further reason that the whole theory of controlling ac¬ 
counts rests more upon a question of mechanism of 
books than upon a question of principles, it may be well 
to make the controlling accounts serve as a connecting 
link between the theory of the books and the general 
classification of the accounts which the books contain. 

Ledgers are frequently referred to as “general” and 
“subsidiary” (or “underlying”). The word general, when 
applied to a ledger, means that the book contains one ac¬ 
count with every value, whether positive or negative, 
which is part of the business as a whole. If, then, sub¬ 
sidiary ledgers are used, it must be that some of the gen¬ 
eral ledger accounts require to be kept more minutely 
than can conveniently be done in the general book. In 
large concerns, for instance, there is sometimes kept a real 
estate ledger in which every parcel of land and every 
building held for investment is given an account of its 
own, while the aggregate amount of the property then 
held is carried in the general ledger. The same thing may 
be done in connection with bonds and stocks of other 
companies, machinery and tools, materials and supplies, 
and, generally speaking, with any account involving a 
variety of detail. Therefore, the term “Controlling 

124 


CONTROLLING ACCOUNTS 


125 

Account,” which is given to ledger accounts recording 
the aggregate of transactions the detail of which is kept 
in other books, applies to a multitude of cases. More 
commonly, however, the term ‘‘controlling” is associated 
with accounts which show the extent of the transactions 
with customers and creditors, as shown in detail by the 
subsidiary ledgers. 

Genesis of the Controlling Account 

It will be readily admitted that even before the 
journal was divided into its integral parts, it was possible, 
for balance sheet purposes, to obtain the net amount due 
from customers, even though the general ledger was not 
entirely posted, or was out of balance. An analysis of the 
journal, if accurately made, would give the sales, the re¬ 
turned sales, and allowances, as well as the settlements 
made by customers and the losses of discounts which they 
involved. But the process was lengthy, and the delay 
might prove irksome to the administrative body, whose 
demand for accurate and timely information concerning 
financial facts was growing apace with the development of 
the business. 

The analytical results given by the books of original 
entry which were subsequently built up from the journal 
root, made it possible to obtain, not only the minutest 
detail of every transaction, but, as well, periodical totals 
of broad classes of facts. This pointed the way towards 
the partial reconstruction of the general ledger. Every¬ 
thing which compelled the handling of a mass of detail 
and retarded the obtaining of financial statements, was 
taken bodily out of the general ledger and transferred to 
subsidiary books where it could be conveniently handled 
by clerks less skilled in the science of accounts than the 
general bookkeeper. To the latter was assigned the task 
of controlling the work of his subordinates. He gathered 


i2 6 theory and technique of accounts 


his facts monthly from the books of original entry; hence, 
if he were certain of the arithmetical accuracy of the data 
reflected by the said books, he could not only arrange his 
material quickly for statement purposes, but could estab¬ 
lish as well the aggregate amount of the individual ac¬ 
counts, the detail of which was to be shown later by the 
lists of balances taken from the subsidiary ledgers. Nor did 
it matter, as far as financial status was concerned, whether 
or not the subsidiary books agreed with his controls. The 
statements were made at all events, and known to be correct, 
since the general ledger was in balance. 

Theory of the Controlling Account 

Thus it was, that the controlling accounts came into 
existence. Basing our definition of them upon their 
origin, we might say: The term “controlling” applies to 
ledger accounts which, by means of the periodical record¬ 
ing of the aggregates of debit and credit transactions 
shown by books of original entry, measure the per¬ 
iodical status of certain broad classes of financial facts 
and, at the same time, control their detail posting in sub¬ 
sidiary books. 

The process of transferring to subsidiary books, ac¬ 
counts which are to be controlled by, instead of being 
kept in, the general ledger, does not involve any unusual 
knowledge of accounting principles; still, the type of 
journal entries necessary to create controlling accounts 
for customers and creditors, and, more generally, all 
journal entries which necessitate a posting to the general 
ledger and another posting to underlying ledgers, are 
confusing to the student of accounting; they appear to 
him to be three-sided, and destructive of that equilibrium 
on which, as he has been told, the whole system of double 
entry rests. Take the case of a journal entry creating a 
customers’ controlling account, for instance: 


CONTROLLING ACCOUNTS 


12 / 


Names and Explanation 


References 
C.L. G.L. 


Dr. 


Customers’ Controlling Account. 

A (Name of Customer). i 

B “ 2 

C “ 3 

D “ 4 

E “ 5 

F “ 6 


To close, in the general ledger, the 
individual accounts of the above 
customers, and transfer the aggregate 
to the controlling account. The in¬ 
dividual accounts are to be carried 
in a subsidiary ledger to be known as 
customers ledger. 


25 

75 

8o 

85 

89 

9 i 

97 


$3,000.00 


Cr. 


$ soo.oo 
150 . 0 G 
100.00 
75-oo 
925-00 
1,250.00 


The journal provides for a debit to the controlling ac¬ 
count, and a credit to each individual account to be 
closed; this, in effect, means that the equilibrium having 
been disturbed by the debit, is reestablished by the credit; 
but another debit to each individual customer’s account 
must be made in the underlying ledger to open the in¬ 
dividual accounts. The student is unable to find a bal¬ 
ancing credit therefor, and begins to believe that the 
whole theory is erroneous. A few words of explanation 
may serve to dispel such doubts, as well as to review some 
of the principles expressed in the preceding chapters. 

All financial books are either journals or ledgers; the 
journal may be kept in its entirety, or it may be cut up 
into its component parts, but whether found under one 
form or the other, it is nevertheless the journal, and its 
nature and its importance do not change. The ledger 
may also be cut up in as many parts as may best be 
adapted to the requirements of the business; for instance, 
there might be a section for impersonal assets, another for 
impersonal liabilities and capital, a third for nominal ac¬ 
counts, and a fourth for personal accounts of customers 









128 THEORY AND TECHNIQUE OF ACCOUNTS 


and creditors; one-half of this last section being personal 
assets, the other half being personal liabilities. To illus¬ 
trate: 


General Ledger in Four Sections 


Impersonal 

Impersonal Li- 

Nominal Ac- 

a. Personal Ac- 

Assets 

abilities & Cap- 

counts, Debits 

counts — Cus- 


ital 

and Credits 

tomers’ 

b. Personal Ac¬ 
counts — Cred¬ 
itors’ 

1 . 

2 . 

3. 

4- 


This would not make parts 2, 3, or 4, subsidiary 
ledgers; it would merely make them units of the whole. 
But if we were to add the balances shown by the individ¬ 
ual accounts in part “a” of section 4, and enter the total thus 
obtained, among the assets found in section 1; if, further, 
we were to do the same thing with the accounts found in 
part ‘T’ 1 of section 4, and embody the amount in section 2, 
we would have: 


General Ledger 

Subsidiary 

Ledger 

Impersonal As¬ 
sets and Con¬ 
trol of Personal 
Assets 

Impersonal Li¬ 
abilities, Capi¬ 
tal and Control 
of Personal Li¬ 
abilities 

Nominal 

Accounts 

a. Personal 
Accounts— 
Customers’ 

b. Personal Ac¬ 
counts — Cred¬ 
itors’ 

1 . 

2 . 

3. 



Thus, we would find in section 1 an account con¬ 
trolling part “a" of the subsidiary ledger, and in section 2 an 
account controlling part “b” of the subsidiary ledger. 























CONTROLLING ACCOUNTS 


129 


It becomes plain that (since the journal establishes 
and maintains the equilibrium between the positive and 
negative values found in the general ledger), when we 
say that two postings must be made of every debit and of 
every credit entry affecting the controlling account of the 
customers or of the creditors, we mean that one of the 
postings is necessary to show that the equilibrium has 
been disturbed and reestablished, owing to the occurrence 
of certain transactions, and that the other posting is 
merely in the nature of a memorandum, involving no prin¬ 
ciple of any kind, and intended merely to contribute to 
the gathering of facts which, in the aggregate, will sup¬ 
port other facts expressed elsewhere in concrete form. 

Self-Balancing Ledger 

One of the indirect applications of the controlling ac¬ 
counts is found in what is sometimes qualified as a “self¬ 
balancing ledger.” Taking the customers ledger as an 
instance, the bookkeeper operating a self-balancing ledger 
of the customers’ accounts, is supposed to post daily the 
details of the transactions affecting them individually, and 
when this is accomplished, to post the total of the said 
transactions into a “control” to which a special place is 
given, either at the beginning or at the end of the book. 
It goes without saying that the data which constitute the 
“control” posting, are supposed to be taken independ¬ 
ently of the detail. Monthly, or oftener, the bookkeeper 
is in a position to control his own work, since the special 
account gives him the aggregate amount which the open 
balances of the individual accounts must reflect and 
support. 

It must be remarked, in connection with the self¬ 
balancing ledgers, that if the subsidiary “controls” are 
really what they claim to be, they reduce the general 
ledger accounts which usually operate in the capacity of 


I3 o THEORY AND TECHNIQUE OF ACCOUNTS 

controllers, to the rank of aggregate asset or liability ac¬ 
counts, that is to say, mere memorandum accounts. 

The accounts which the private ledger and the gen¬ 
eral ledger keep one with the other, are sometimes quali¬ 
fied as “controlling.” The same is true of the general 
ledger and of the income ledger. This, however, is con¬ 
trary to principles. We have seen that the effect of a 
controlling account is to eliminate from the general 
ledger the detail of what was originally a part of that 
book, and that the part thus removed becomes a sub¬ 
sidiary unit of the accounting scheme. Few accountants 
would be willing to say that the general ledger is a sub¬ 
sidiary of the private ledger because the latter contains a 
controlling account with the former, and that, for the 
sarrte reason, the private ledger is a subsidiary book of the 
general ledger. In reality, the accounts which one sec¬ 
tion of the ledger contains with other sections of the same 
book are not controlling accounts, but balance accounts, 
precisely as the would-be “control” of the self-balancing 
subsidiary ledger is only a balance account. 


CHAPTER XII 


CLASSIFICATION OF ACCOUNTS 

General Classification 

For purposes of general classification on the basis of 
financial status and earning capacity, accounts are classi¬ 
fied as: 



i. Real Accounts 


Impersonal Accounts 
f Fictitious, Economic, Loss 


2. Nominal Accounts a and Gain, Representative 


Accounts 


3. Accounts Partially Real and Partially Nominal 

x. Real Accounts 

Accounts are said to be real when they represent 
positive or negative elements of invested values, the net 
amount of which measures the equity of the proprietor in 
positive values. In other words, the real accounts are all 
the assets and the true liabilities, the latter term excluding 
accounts expressing proprietorship, accounts of sole traders, 
and accounts of copartnerships. Liabilities resulting from, 
or incident to, the issue of capital stock, are real liabilities, 
as will be seen later, when speaking of capital stock. 

Real accounts are subdivided into personal and im¬ 
personal. The personal accounts include all the accounts 
with persons, whether such persons have an individual ac¬ 
count in the general ledger, or whether the aggregate of 
their accounts is reflected by a controlling account. The 
term “impersonal” applies to all other real accounts. 


131 


! 3 2 THEORY AND TECHNIQUE OF ACCOUNTS 

2. Nominal Accounts 

The term “nominal” applies to all accounts opened 
during the accounting period to record the causes for 
such fluctuations of real accounts as have resulted in an 
operating loss or gain, an expense, an addition to, or a 
deduction from, income. They are called nominal be¬ 
cause, in so far as inventorial vklue is concerned, they 
exist in name only. Cash, buildings, land, are called real, 
because they exist in some tangible form; good-will is 
called real, because, although intangible, it has or is sup¬ 
posed to have a salable value; interest (received or paid 
otherwise than in advance) is called nominal, because it 
represents no inventorial value, tangible or intangible, 
positive or negative. Interest merely gives the result of 
a series of transactions the effect of which has been to 
bring about the income or the outgo of a value (cash or 
claim) in exchange for financial assistance given or 
received. 

The term “fictitious” which is sometimes applied to 
nominal accounts is objected to by many accountants, 
because of the generally accepted meanings of the word, 
i.e., imaginary, false, not genuine, fabulous, etc. It is 
not easy to see how misleading accounting terminology 
can in any way make clear to the student the principle 
underlying the nominal accounts. 

The term “economic accounts” is also given to nom¬ 
inal accounts. The word economic means: pertaining to 
the management of the household, the state, the nation, 
the business, etc. And as it is through management that 
gains are made, losses sustained, and expenses incurred, 
it follows that every account recording such occurrences 
may rightly be termed economic. 

The expression “loss and gain accounts” is open to the 
objection that it tends to obscure principles by convey¬ 
ing the idea that expenses are losses. “Salaries,” for ex- 



CLASSIFICATION OF ACCOUNTS 


133 


ample, which some textbooks call a loss and gain ac¬ 
count, is not a loss, but an expense necessary to obtain 
for the business the benefit of the services which it re¬ 
quires. To call expenses losses, is to ignore one of the 
main purposes of accounting, which is to differentiate be¬ 
tween them. 

The word “representative” is also sometimes used in 
connection with the accounts which show causes. It is 
said of them, to explain the use of the term, that they 
“represent” the particular subject matter which their 
name indicates. Thus, rent is called a representative ac¬ 
count, because it represents the transactions relating to 
rent. 

3. Accounts Partially Real and Partially Nominal 

The assets of a concern may be said to be invested, or 
acquired: 

1. To remain permanently invested in the business 

and serve as a basis for operations 

2. To be used as current resources, that is to say, 

as financing media 

3. To be sold at a profit, either in the very form in 

which they were invested or acquired, or after 
they have been subjected to a process altering 
their nature 

4. To be consumed pending operations, for the 

benefit of the business as a whole 

Groups 1 and 2 are real values at all times, and the 
fluctuations to which they are subject are accounted for 
by nominal accounts in all cases where the fluctuations 
have resulted in increases or decreases. 

Group 3 contains elements which, under certain 
methods of accounting, may be partially real and partially 
nominal. If, for instance, a merchandise account is kept, 


!34 THEORY AND TECHNIQUE OF ACCOUNTS 

it contains a real element the value of which is ascertained 
only at inventory times, and a nominal element the ex¬ 
tent of which is known as soon as the real element is ob¬ 
tained. Of this, more will be said later. 

As to group 4, if the items which it contains are 
shown by inventory to have been consumed entirely, the 
accounts representing them have ceased to be partially 
real, and have become essentially nominal. If they are 
shown not to have been entirely consumed, their inven- 
torial value is real, the consumed proportion is nominal, 
and the accounts must be relieved of either the real or the 
nominal elements, as will be shown subsequently. 

Asset and Liability Classification 

_ 0 1 ' * r * . 

For purposes of recording and expressing the finan¬ 
cial status of a business, accounts are classified as: 

1. Asset Accounts, including: 

All real values actually possessed, or earned and 
receivable, as well as all prepayments ap¬ 
plicable to periods subsequent to any par¬ 
ticular period 

2. Liability Accounts, including: 

a. For Corporations: 

(1) The liabilities to outsiders 

(2) The liability of the artificial being 

“The Corporation” to the stock¬ 
holders, at time of dissolution, for: 

(a) The outstanding capital stock 

(b) All the surplus earnings not 

declared in dividends 

(c) The income and the benefits 

held out of surplus, for ap¬ 
plication to the profits of 
subsequent periods 

(d) Unapplied reserves 


CLASSIFICATION OF ACCOUNTS 


135 

b. For Sole Proprietorships and Copartner¬ 
ships: 

(1) The liabilities to outsiders 

(2) The proprietorship accounts, repre¬ 

sented by: 

(a) Capital accounts 

(b) Undrawn, undistributed, or 

unapplied profits 

(c) All credit accounts which do 

not constitute liabilities to 
outsiders, whether re¬ 
serves unapplied or per¬ 
sonal credit accounts 

Assets and Asset Accounts 

The word “asset” comes from the French word “assez” 
or from the Provencal “assatz,” both meaning “enough” 
or “sufficient.” Commenting upon assets, Blackstone 
says that “the term receives its name because its posses¬ 
sion is sufficient to render the executor or administrator 
liable to discharge the debts and legacies of the deceased 
person, so far as the assets may be sufficient for the pur¬ 
pose.” 

The report of the special committee of the American 
Association of Public Accountants, on accounting terminol¬ 
ogy, defines assets: “Property, fixed or liquid; resources 
of any kind capable of being converted into money or value. 
The term is used sometimes* as applying to good-will, 
concessions, franchises, deferred charges, and in English 
accounting even to preliminary expenses incurred in the 
formation of a company.” Greendlinger’s “Accounting 
Practice” states broadly that “any part of a man’s property 
or business that may be used for the extinction of his debts 
is called assets.” Bentley’s “Science of Accounts” speaks 
of assets in these terms: “The assets of a business are 
anything of value belonging to it, such as real estate, ma- 


I3 6 theory and technique of accounts 

chinery, horses and wagons, office furniture, book debts, 
notes receivable, merchandise on hand, insurance premiums 
paid in advance, etc.” 

The accounting meaning of the word “assets” does not 
appear capable of being reduced to general definitions like 
the above, for values may be assets under certain condi¬ 
tions and not under others; nor is it necessary that a value 
“may be used for the extinction of a man’s debts” in order 
that it may be raised to the dignity of an asset. Sta¬ 
tionery and printed matter, for instance, are often referred 
to as assets of a going concern; still they might have no 
value available for the liquidation of any of the debts of 
the business. It seems, then, that the definition of assets 
might be extended to cover their peculiarities. The term 
“assets,” when this is done, means: 

1. For a going concern: 

That which is owned and invested in the busi¬ 
ness; that which is earned, although not 
received, and constitutes a collectable claim; 
that which has been expended for the bene¬ 
fit of future periods 

2 . For a concern about to liquidate: 

a. If the concern enjoys the benefit of limited 

liability: 

That which is owned, invested in the 
business, and convertible into re¬ 
sources applicable to the liquida¬ 
tion of the liabilities of the concern 

b. If the concern does not enjoy the benefit of 

limited liability: 

That which the proprietors of the busi¬ 
ness own and is not exempt by law 
from being seized and converted 
into resources applicable to the 
liquidation of their liabilities. 


CLASSIFICATION OF ACCOUNTS 


137 


Asset accounts are the accounts in which are recorded 
the initial value of assets, and all subsequent transactions 
affecting them. 

Liabilities and Liability Accounts 

There is perhaps no term used in accounting which 
has caused so much discussion as the word liability. Ac¬ 
cording to the revised edition of the Encyclopaedic Dic¬ 
tionary, liability means: “The quality or state of being 
liable, responsible, or bound in law or justice. That for 
which one is liable; specifically the debts or pecuniary en¬ 
gagements for which one is liable.” The report on ac¬ 
counting terminology which has been mentioned in con¬ 
nection with assets, says that “liabilities embrace all the 
debts or obligations due by the firm to its creditors, or the 
debts and obligations of a corporation, partnership or in¬ 
dividual.” Lisle says that “the liabilities of a business 
consist of all the sums due to outside creditors, as distin¬ 
guished from the sums due to partners or stockholders.” 

The foregoing definitions do not appear to take into 
consideration the manifold phases of liabilities; they seem 
to ignore the ever-present possibility of accountabilities 
becoming liabilities as a direct result of the materializa¬ 
tion of contingencies. 

The liabilities of a going concern may be said to be: 

1. Those which are past due. 

2. Those which are due, but not as yet payable, in 

consequence of the terms of credit extended. 

3. Those for which indebtedness has been incurred, 

but which are, at present, neither due nor 
payable. 

4. Those for which the possibility of becoming 

liable depends upon contingencies of the 
future. 


I3 8 theory and technique of accounts 

On the other hand, the word liabilities might be made 
to apply, for a concern enjoying limited liability, and 
about to liquidate, to: 

1. Those which are due, about to become due, or 

certain to become due as a direct result of 
operations, and payable out of the proceeds 
of the sale of invested assets. 

2. Those which will become due if certain contin¬ 

gencies materialize. 

3. The remainder of the assets (if any) after liquida¬ 

tion of all liabilities to outsiders, which the 
proprietors will withdraw from the enterprise, 
or which the corporation in its capacity as an 
artificial being about to lose its legal entity, 
owes to the stockholders. 

Lastly, the liabilities of a concern not enjoying the 
privilege of limited liability and about to liquidate, might 
be said to be: 

Those which are due, about to become due or certain 
to become due upon the materialization of con¬ 
tingencies, and are payable out of the proceeds of 
the sale of any value owned by the members of the 
concern which is not exempted by law from 
seizure, whether or not it is invested in the busi¬ 
ness. 

Liability accounts are so named because they record 
the original amount of the liabilities, and all subsequent 
transactions in regard thereto. 


Part III The Theory of the Asset Accounts 


CHAPTER XIII 

CASH ACCOUNT—PETTY CASH 


The Theory of the Cash Account 

Under the tenets of the personalistic theory of ac¬ 
counts the cash account is, in principle, an account with 
the cashier. Without going into the merits of that 
theory, it may be said to have the advantage of restricting 
the treatment of cash to the recording of actual receipts 
and disbursements. This may sound like a truism, and 
it will no doubt be advanced that the same restrictions 
apply, no matter under what theory the cash account is 
kept. Still, every accountant knows that a great many 
ledger accounts with cash contain items which are called 
receipts merely because they have not been disbursed, and 
items which are called disbursements merely because they 
have not been received. It is because this latter treat¬ 
ment is not generally thought to be wrong, that so many 
students of accounting find great difficulty in solving 
practical problems which present the cash account of a 
trustee, without stating as receipts the proceeds of the 
securities held for creditors and sold for them under the 
indenture of the pledge, and as disbursements the reduc¬ 
tion or the liquidation of fully or partially secured liabili- 

139 



I 4 o THE theory of the asset accounts 

ties. It is also because the average bookkeeper does not 
clearly understand the purpose of the cash account that 
so many entries are made which deprive the books of a 
concern of that harmonious relation which should exist 
between them and the books of all other concerns with 
which business relations have existed. Let us illustrate the 
cash account by the following example: 

A owes Bank B $50,000, representing a time loan se¬ 
cured by 600 shares of stock, of par value of $100 each, 
which A carries on his books at $59,500. A being unable 
to meet the loan at maturity, the bank sells the securities 
for $57,000, deducts from the proceeds the principal of the 
loan, plus $1,500 of interest due under the loan, and 
credits A with the balance, i.e., $5,500. 

If we were to examine the books of Bank B we would 
find, as a result of the foregoing: 

Cash.debited with $57,000.00 

Loans Receiv¬ 
able .credited with $50,000.00 

Accrued Interest 

on Loans... .credited with 1,500.00 

A. .credited with 5,500.00 

If, on the other hand, we were to examine A’s books, 
it is not improbable that we would find: 


Cash.debited with $57,000 

Investments.credited with $57,000 

Cash .credited with 5 L 5 °° 

Loans Payable.debited with 50,000 

Interest Accrued on 

Loans.debited with 1,500 

Investments.credited with 2,500 

Profit and Loss.debited with 2,500 












CASH ACCOUNT—PETTY CASH 


141 

Whereas, if proper respect had been paid to the pur¬ 
pose of bookkeeping and to the principles underlying the 
double-entry system, we should have found on A’s books: 

Cash .debited with $5,500 

Interest Accrued on 

Loans.debited with 1,500 

Loans Payable.debited with 50,000 

Profit and Loss.debited with 2,500 

Investments .credited with: 

Cash $ 5 , 50 ° 

Sundry 54,000 

This latter handling of the facts would make A’s books 
harmonize perfectly with the books of the bank, in so far 
as the loan transaction is concerned, and besides would 
have the advantage of applying the following principle: 

The outgo of a positive value (investments) has been 
counterbalanced by: 

1. The income of a positive value (cash) 

2. The outgo (liquidation) of two negative values: 

a. Loan principal 

b. Loan interest 

3. A loss sustained through the sale of a ledger asset 

The first set of entries makes it appear that the bank 
has paid A $57,000; that A has paid back to the bank 
$51,500; that because the bank has paid A only $57,000, 
A has suffered a loss of $2,500, since his property, which 
the bank held, was worth $59,500. What makes matters 
worse, is that A’s ledger, being posted from his cash book, 
shows that loans payable and interest accrued on loans 
were repaid in cash. If we had taken an abstract of A’s 
ledger for audit purposes, and we were attempting to find 
documentary evidence of the individual transactions sup¬ 
porting the totals shown by the abstract, we would look 







142 


THE THEORY OF THE ASSET ACCOUNTS 


in vain for evidences of the above disbursements. Nor 
could we find anywhere in the statements furnished by the 
bank a credit to A of $57,000. Reverting to the ledger 
account with cash, we would find that while the initial 
and closing balances are correct, the intervening facts on 
both sides are misleading in so far as they do not reflect 
what took place. 

In view of the foregoing, it may be said that the theory 
of the cash account demands that it shall be made to re¬ 
flect actual, not theoretical, receipts and disbursements, 
and a balance resulting from actual positive and negative 
facts, which can be readily proved and supported. To 
make this possible, the cash journal must be used strictly 
as the scales in which the cash transactions are to be 
weighed as they occur, and not as they might occur. 

The Cash Account and the Cash Balance 

One of the disadvantages of the cash account as it is 
usually kept, no matter whether or not the foregoing 
principles are applied, is that under the generally estab¬ 
lished method of crediting cash when a check is drawn 
instead of when it is paid by the bank, the ledger account 
with cash may not represent the actual amount of cash in 
bank. To some accountants this spells misrepresentation 
of the facts. They claim that a check being an order to 
the bank to pay cash, the financial status of the enter¬ 
prise has not changed until the payee under the order has 
presented it to the bank, and has actually received pay¬ 
ment. This, of course, means that since the check was 
issued to liquidate a liability, the liquidation has not taken 
place, and the liability exists until the check is paid. Go¬ 
ing still further, they say that if on December 31 the books 
of A show that he has paid B $50, while the books of B 
say that A still owes him $50, one set of books does not 
state the truth at December 31. 


CASH ACCOUNT—PETTY CASH 


143 


We may, with all propriety, decline to allow a love 
for logic to lead us so far from the domain of actuality. 
Still we must, in all justice, present the favorite argu¬ 
ments of all schools. It has been said that a cash account 
which does not show the true balance held by the de¬ 
positories to the credit of a concern is useless in checking 
the accuracy of the interest credited by a trust company, 
say, on daily balances. 

A Correct Cash Account 

This is not the place for a discussion of the merits of 
the foregoing claims, but it is the place for the presenta¬ 
tion of a very interesting handling of the account with 
cash, which some railroads, and at least one of the largest 
life insurance companies, have adopted, either substanti¬ 
ally as given in the following or with slight alterations. 
The method may, or may not, be the result of the belief of 
its originators in the accounting fallacy of the one which 
it replaces, but, strangely enough, it is not subject to any 
of the criticisms which have been made of its rival. Its 
proper operation requires, besides the keeping of the usual 
financial books: 

1. That all expenses incurred and all payments to be 

made be entered in a voucher record (or a series 
of records assigned to typical classes of ex¬ 
penses). 

2. The keeping of as many check registers as there 

are depositories. 

3. A ledger account with audited vouchers unpaid. 

4. A treasurer’s memorandum book intended to show 

daily the available balance of cash subject to 
check. 

I ' j ] i 

It presupposes an arrangement whereby the depos¬ 
itories will agree to return daily the canceled checks. This 


(ledger, account) 


144 


THE THEORY OF THE ASSET ACCOUNTS 



Figure 2/. Cash Account 




















































a*® a Amount 


CASH ACCOUNT—PETTY CASH 


145 





Figure 28. Check Register 































































































TREASURER'S MEMORANDUM OF AVAILABLE CASH 


146 THE THEORY OF THE ASSET ACCOUNTS 



Figure 29. Treasurer's Memorandum 





















































CASH ACCOUNT—PETTY CASH 


147 

vital prerequisite of the method is sufficient to make it 
impracticable to the average concern. 

As to its technique: 

The checks drawn are recorded daily in the proper 
check register, and the amount drawn is recorded by the 
treasurer in his memorandum book of available cash. The 
check registers provide for the insertion of the numbers 
of the vouchers for which checks are drawn, as well as for 
any other information which may facilitate checking from 
book to book. 

The amount of canceled checks returned by the banks 
is posted daily in the cash book to the credit of cash, and 
to the debit of audited vouchers unpaid. The returned 
checks are also recorded in the check register and in the 
voucher record. 

At the end of a given month, the situation is as fol¬ 
lows: 

1. The ledger account “Cash” represents exactly the 
balance held by the banks to the credit of the concern. 

2. The treasurer’s memorandum book of available 
cash shows the amount of funds held by the banks, against 
which the concern can draw by check. 

3. The cash book makes it possible to obtain the daily 
balances, and to compute the amount of interest which 
has been earned. 

4. The ledger account “Audited Vouchers Unpaid 

1 

represents: 

a. The amount of vouchers for which no check has 

been drawn 

b. By reference to the check register, the amount of 

vouchers for which checks have been drawn but 

remain unpaid 

5. The voucher record gives, no matter how required, 
the exact detail of the liability for audited vouchers un¬ 
paid. 


! 4 8 THE theory of the asset accounts 

6. The balance sheet shows: 

a. As the books stand, what is sometimes called 

the only true financial status of a concern. 

b. By the application of the following journal 

entry the financial status of the concern as it is 
customary to present it: 

Audited Vouchers Unpaid. . $.. .. 

To Cash. $.... 

The amount of vouchers 
for which checks have 
been issued, but are 
still unpaid by banks. 

Expressed in book totals and ledger accounts, the 
cash situation, say at June 30, 1914, irrespective of former 
balances, is shown by Figures 27-29. 

Nature of Petty Cash 

Petty cash may be: 

1. A part of the cash receipts of a certain period, re¬ 
corded in the cash book, but not deposited in the bank be¬ 
cause it is to be used for small current disbursements. 
In this form, petty cash is part of general cash, and should 
figure in the cash book balance of the funds available at 
the end of the period. Disbursements made out of petty 
cash are temporarily withheld from the cash book, to be 
recorded periodically, or when they have reached a stated 
amount. Any petty cash book which may be used under 
this method of handling petty cash, is merely a memo¬ 
randum which has no part in the scheme of the financial 
books of the concern. No entry of any kind is necessary 
to record the withholding of receipts for petty cash 
purposes. 



CASH ACCOUNT—PETTY CASH 


149 


2. An amount withdrawn from the bank, the with¬ 
drawal being recorded in a ledger account known as 
“Petty Cash,” raised to reflect the outgo of small sums 
of cash disbursed currently for items of expense which are 
too small to be conveniently paid by check. In this form, 
the account is independent of the general cash account, 
and its balance does not figure in the cash book balance 
of available cash (unless sent back to it periodically). The 
petty cash book is also an independent journal which is 
used as a posting medium, precisely like its more im¬ 
portant prototype, the general cash journal. 

The expression in general journal form, of the cash 
book entry creating a petty cash account as described in 
class 2, is: 

Petty Cash. $.. .. 

To Cash. $.... 

The expression in general journal form, of the entry 
necessary to record the petty cash disbursements of the 
period in the proper general ledger accounts, is, say: 


Telephone and telegrams. $ 7 - 5 ° 

Postage . 5 °° 

Office supplies. 2.30 

General expense. 17.20 

To Petty Cash. $32.00 


To record the petty cash transactions 
of the period. 

3. An amount withdrawn from the bank, and set up as 
a fund intrusted to a petty cashier whose duty it is to 
give change and to make all disbursements for petty ex¬ 
penses, and in settlement of invoices deemed too insig¬ 
nificant to be passed through the purchase journal. The 
fund is recorded in a special ledger account, bearing as a 









THE THEORY OF THE ASSET ACCOUNTS 


x 5° 



Figure jo. Statement of Petty Cash Disbursements 
























































































CASH ACCOUNT—PETTY CASH 


I 5 I 

title “Petty Cash Fund,” or “Petty Cash Fund—John 
Doe,” or some other appropriate name. 

The expression in general journal form, of the cash 
book entry creating this class of petty cash, is: 


Petty Cash Fund—John Doe. $_ 

To Cash. $_ 


To create an imprest fund, to be 
used by John Doe for petty cash 
disbursements. 

This method of treating petty cash differs from the 
one described under 2, in that it is supposed to show no 
fluctuations. Until returned to the general cashier it 
remains on the ledger at the same figure. In order to 
make this possible, all sums of money paid out by the 
petty cashier are returned to him periodically, or when¬ 
ever the petty cash fund has been depleted to a stated 
figure. 

Maintaining the Imprest Fund 

When the petty cashier desires to replenish his fund 
he presents to the general cashier a statement setting 
forth his expenditures, supported by proper vouchers. 
The statement may be as shown in Figure 30. 

The voucher may assume a much simpler form; the 
essential point is that the general cashier may readily 
obtain the data necessary to properly record in the cash 
book the expenditures made for him by the petty cashier. 
The check issued is either cashed by the petty cashier at 
the bank, or cashed by the general cashier himself. Which¬ 
ever way it is done, the fund of the petty cashier is now re¬ 
stored to its original amount. The expression in general 
journal form of the entry made by the general cashier in 
the cash book is: 




*5* 


THE THEORY OF THE ASSET ACCOUNTS 


A*. 

B. 

C . 

D... 

E. 

G. 

To Cash. 

For disbursements made by the 
petty cashier. 


$40.00 

20.00 

65.00 

20.00 

72.20 

32.8° 

$250.00 


Theory of the Imprest Fund 

It will be noticed that at the time the fund was cre¬ 
ated, the cash book entry merely recorded the setting 
aside of a portion of the asset “cash,” for purposes of petty 
disbursements. Thus the cashier set apart from his gen¬ 
eral funds, a sum of money which he intrusted, as an “im¬ 
prest” fund (money advanced, money loaned, money in¬ 
trusted to a paymaster), to the petty cashier. This ex¬ 
plains why the word “imprest” is used in qualifying the 
above mentioned method of handling petty cash. The 
system appears to have originated in the Imprest Office 
of the British Admiralty, in connection with the disburse¬ 
ments made by subaltern paymasters for the account of 
the general paymasters. 


Special Duties of the Petty Cashier 

In some concerns one of the duties of the petty cashier 
is to cash checks for the officers, the clients or the cus¬ 
tomers, and the employees. This brings about complica¬ 
tions which necessitate the opening of a special bank ac¬ 
count in the name of the petty cashier. He deposits daily 
to his credit the checks which he has cashed, and draws 
against the account whenever he requires funds. The 
handling of the fund is the same as indicated in the fore¬ 
going, but the memorandum petty cash book is arranged 
to show the exchange and bank transactions. (Figure 31.) 


* Letters refer to ledger accounts. 










CASH ACCOUNT—PETTY CASH 


*53 



Figure j/. Petty Cash Book 
































































































































































CHAPTER XIV 


ACCOUNTS WITH CUSTOMERS 

r 1 ' F 

i 

Entries in Customers’ Accounts 

Cash may be affected by such a diversity of transac¬ 
tions, that it is not possible to state in advance the sources 
from which it will come or the channels through which 
it will go. Hence, it may be said of the cash account that 
it possesses no well-defined mechanism. In contradis¬ 
tinction, the customer’s account presents a series of 
anatomical units with which we may become so thor¬ 
oughly familiar as to be able to locate and assemble them 
readily, no matter how scattered they may be. 

As soon as the word customers is mentioned, the mind 

v. 

of the accountant reverts naturally to the business trans¬ 
actions which affect their status on books of record. We 
think of charges to them for: 

1. Sales on credit 

2. Refunds when, having overpaid their accounts, 

they receive back that which was paid by them 
without being due 

and of credits to them for: 

ii 

1. Returned sales 

2. Settlements by them in cash or its equivalent 

3. Deductions from the amount receivable from them 

in the line of cash discounts, trade discounts, 
allowances for defective goods, damaged goods, 
old goods, shortages in shipments, freight paid 
by them and chargeable to the vendor, etc., etc. 

154 


ACCOUNTS WITH CUSTOMERS 


*55 


Trade Discounts 

The only one of the foregoing components of the cus¬ 
tomer’s account which might confuse the student, is trade 
discounts. 

Trade discounts are said to be “deductions from price 
lists allowed to the trade.” They differ from cash dis¬ 
counts in that the taking advantage of the latter depends 
upon the financial status or prompt payment of the one 
to whom it is offered, whereas the amount of the former 
will positively not be included in the customer’s remit¬ 
tance. A bill might include two kinds of discounts: one 
of, say, 10% to be deducted from the face of the bill, and 
another of, say, 2% to be similarly deducted provided re¬ 
mittance is made within ten days. It is clear that unless 
the debtor is in a position to pay within the allotted time, 
the only deduction which he can make from the bill is for 
the trade discount which, under all conditions, is no part 
of the contract of sale to which he has become a party. 

If the policy of the concern is to charge all its cus¬ 
tomers with the list or catalogue price, there are two pos¬ 
sible ways of relieving the accounts of the beneficiaries of 
trade discounts, of the excess charged to them over the 
amount which they are expected to pay: 

1. Let the customers deduct the trade discounts from 

their remittances, and use the cash book as the 
journal through which they will receive credit 
for the amount not remitted. 

2 . Before the customers remit, clear their account by 

journal entry crediting them and debiting: 

(a) Trade Discounts 

(o) Merchandise, or Sales, or any other account 
which may have been originally inflated 
on the credit side by the amount of the 
trade discounts 


i5 6 the theory of the asset accounts 

It will be noticed from the above that the treatment 
indicated under “a” compels the raising of a general 
ledger account with trade discounts; whereas the second 
treatment, “b,” eliminates the account entirely. This 
means that, in the first instance, there has been created a 
special nominal account measuring the extent of the de¬ 
duction from the income to be received from sales, due to 
the desire of the administration to favor dealers in order 
that other expenses (such for instance, as advertising, or 
salesmen’s salaries and commissions) may be correspond¬ 
ingly reduced; and that, in the second instance, the special 
nominal account has been avoided, in order that the 
already existing account with merchandise or with sales 
may show the net result of the sales as far as income is 
concerned. 

If the policy of the concern is to charge all customers 
with the net amount collectable under the contract of 
sale, there can be no ledger account with trade discounts, 
and that component will be found neither in the account 
with customers, nor in the account with merchandise. 
Hence, whatever information might be required in re¬ 
gard to the extent of the reductions which have been 
made from the catalogue price, is lost in so far as the 
ledger is concerned, and must be sought elsewhere. 

“Accounts Receivable” 

Before leaving the subject of customers’ accounts, it 
may be well to call to the attention of the student the 
fact that the term “Accounts Receivable,” which is often 
applied to them, is to be condemned so far as the general 
ledger is concerned. The term as generally understood, 
refers to a balance sheet group, which is likely to embrace 
a multitude of accounts other than with customers. Since 
the balance sheet is a financial statement purporting to 
show the true financial condition of the concern at a given 


ACCOUNTS WITH CUSTOMERS 


157 


date, it can afford to speak in concrete form, and to state 
broad classes of facts which, if not sufficiently illuminating 
by themselves, can be supported by explicit schedules. It 
is eminently proper for it to include in the group “Ac¬ 
counts Receivable,” accounts current with customers, ad¬ 
vances to agents, and claims against transportation com¬ 
panies which have been recognized as valid and are await¬ 
ing settlement, etc. But it is not proper for the ledger to 
speak vaguely; it must index the facts with at least as 
much care as the journal takes in weighing them, and it 
must adopt a terminology which will place each account 
in a position to state clearly what it contains. 


CHAPTER XV 


NOTES AND BILLS RECEIVABLE 
Notes Receivable 

F. A. Cleveland, in “Funds and Their Uses” says of 
promissory notes: 

“A promissory note is a written contract for the future 
delivery of a specified sum of money * * * The delivery 
must be made on or before a stated time, and nothing will 
satisfy the contract except the delivery of the particular 
thing promised.” 

Treatment of Notes Receivable 

Assuming that a promissory note has been given by a 
customer in settlement of his account, it would appear 
from the above definition that the execution of the in¬ 
strument of credit has so altered the status of his account 
that the change must be recorded. He has indeed entered 
into a second contract quite different from the contract 
of sale under which he became liable for the goods sold to 
him on credit; he has substituted a written promise to 
pay a certain sum of money in a determinate future, for an 
oral or implied promise to pay a certain sum of money 
within a time more or less definite. While under the terms 
of the first contract, he could reduce his liability by mak¬ 
ing claims for allowances, or even by returning part of the 
goods sold to him, nothing will satisfy the second con¬ 
tract, except the delivery of the particular thing promised. 
Still, there are accountants who claim that since the con¬ 
sideration for the second contract is precisely the same as 


NOTES AND BILLS RECEIVABLE 


159 


the consideration for the first contract, nothing has hap¬ 
pened, so far as accounting is concerned, on account of 
the execution of a promissory note, and no entry is neces¬ 
sary in the customer’s account until the note has been met 
at maturity, or discounted. 

Nevertheless, it appears to be the almost universal 
custom to credit customers with the amount of the prom¬ 
issory notes which they give in settlement of their ac¬ 
counts. This treatment of the matter is based upon the 
theory that an open account with a customer must be 
proved if contested, whereas the promissory note is prima 
facie evidence of value received; that the time at which 
settlement of an account current is demanded does not 
alter the liability of the debtor, whereas the maker of a 
promissory note is liable only if the instrument is pre¬ 
sented for payment at the specified time, and surrendered; 
that when the payee under a note sues the party who gave 
it and dishonored it, he does not sue for payment of a 
customer’s account, but for payment of the note. 

The usual way of treating the general ledger account 
with notes receivable is to debit it with the face value of 
the notes received, the counter entry being a credit to the 
customers’ controlling account,* and, if the occasion de¬ 
mands, to an account with interest for the excess which 
the note carries over the value of the account for which 
it settles; and to credit the account with the amount of 
the note when it is met at maturity, or as soon as it has 
been discounted at the bank, the counter entry being a 
debit to cash, in the first instance, and a debit to cash and 
to interest and discount in the second instance. 

Treatment of Contingent Liability on Notes Discounted 

The discounting of notes receivable raises the ques¬ 
tion of the liability of the one who has discounted it, to 

* This, of course, necessitates a credit to the account of the customer in the 
subsidiary ledger. 



!6 o THE theory of the asset accounts 


the broker or bank which has purchased the paper. Leslie 
J. Tompkins says in regard to the liability of the parties to 
a note: “Every party to a negotiable instrument, whether 
he be the drawer or maker, acceptor or indorser, enters 
into a contract which, in some respects, differs from that 
entered into by each of the other parties named. This 
contract carries with it certain liabilities which he cannot 
evade.” Since the customer’s note has been transferred 
to the discounting bank by indorsement, it follows that 
the liability of the transferrer is contingent upon the dis¬ 
honor of the note at maturity. The desire to express this 
contingent liability on the books of concerns which re¬ 
ceive many promissory notes and discount them regu¬ 
larly, has brought about a handling of the account with 
notes receivable, which appears to give quite a twist to 
the principles of double entry. 

We have said that an incoming value is counterbal¬ 
anced by an outgoing value equal, inferior, or superior to 
it. Applying this principle to the discounting of a prom¬ 
issory note, we would say that there has come in a value 
(cash) inferior to the outgoing value (promissory note re¬ 
ceivable) and that, as a consequence, there has come into 
the business a loss under the form of discount. Thus, 
equilibrium having been disturbed by the outgo of the 
note, has been reestablished by the receipt of cash, and 
the recording of a loss equivalent to the excess of the 
outgo over the income. But under the theory that the 
contingent liability must be recorded, this is what takes 
place: ' 

Notes Receivable remains unaffected in so far as the 
books are concerned; Cash is debited with the amount re¬ 
ceived, Interest and Discount is debited with the amount 
charged by the bank, and a liability account known as 
“Promissory Notes Discounted” is credited. As soon as 
information is obtained in regard to the payment of the 


NOTES AND BILLS RECEIVABLE 

notes at maturity, the liability account is debited, and 
Notes Receivable is credited with the face value of the 
note which has been met. 

If we were to submit this treatment to the rigid test of 
the principles of accounting, we would see that it does 
not express the transactions as they occurred. When the 
bank discounts a note, it does not purchase the vendor’s 
contingent liability under the note; nor does it give its 
money in exchange for that liability. It purchases a com¬ 
mercially negotiable instrument which, at the time of sale, 
was recorded on the books of the vendor concern as an 
asset. In other words, it purchases an asset. Of course 
the bank buys the instrument subject to its being met by 
the maker at maturity, and if the instrument proves with¬ 
out value, the purchaser will call upon the vendor to make 
good the loss; but that liability of the vendor is prob¬ 
lematic, whereas there is no question but that his asset 
“notes receivable” has been sold. This is precisely the 
reason why some accountants object to showing the lia¬ 
bility for discounted notes on the balance sheet otherwise 
than as a footnote. Somewhere between the two 
methods, other accountants claim to have found the only 
true expression of the facts. They show the notes receiv¬ 
able at the full value of the instruments unmatured, 
whether held or discounted, and deduct therefrom on the 
asset side of the balance sheet, the contingent liability. 
Hence, the asset as extended represents the exact value 

of the notes held. 

/ 

Dishonored Notes 

In regard to the dishonor of promissory notes at ma¬ 
turity, the handling differs according as to whether they 
were discounted or held until due date. In the former 
case, the treatment differs also as to whether the record¬ 
ing of the discount was made in the account “Promissory 


t 62 the theory of the asset accounts 

Notes,” or in the “Contingent Liability” account. Dis¬ 
honored notes which have previously been discounted and 
credited to the asset account, are treated as follows: 

1. Credit Cash with the amount of the note and of 

the protest fee paid to the bank. 

2. Debit the maker of the note with the face value of 

the dishonored instrument, as well as with the 
amount of the protest fee, or: 

Debit customers’ controlling account with the 
face value of the note and the amount of the fee. 

Dishonored notes which have been discounted, and 
credited at the time to the contingent liability account 
“Promissory Notes Discounted,” require the following 
entries: 

1. Credit Cash with the amount of the note and of 

the protest fee paid to the bank. 

2. Debit “Promissory Notes Discounted” with the 

face value of the note, and the maker of the in¬ 
strument with the protest fee. 

3. Credit Notes Receivable with the face value of the 

note. 

4. Debit the maker of the note with the face value of 

the dishonored instrument, or: 

Debit customers’ controlling account with the 
face value of the note, and the amount of the 
fee. 

Dishonored notes which have not been discounted, re¬ 
quire the following entries: 

1. Credit Notes Receivable with the face value of the 

note. 

2. Credit Cash with the amount of the protest fee 

paid. 


NOTES AND BILLS RECEIVABLE 


163 

3. Debit the maker of the dishonored instrument 
with the face value of the note as well as with 
the amount of the fee, or: 

Debit customers’ controlling account with both 
the amount of the instrument, and the amount 
of the fee. 

The theory underlying the debit to the maker of the 
dishonored instrument, is to the effect that since the note 
so altered the status of the customer’s account that it 
had to be closed, it cannot now be reopened. 

The theory underlying the debit to the customer who 
gave the promissory note which is now dishonored, is to 
the effect that the consideration for the promissory note 
being the same as the consideration for the recording of 
the claim against the customer in the first instance, it is 
quite correct to reopen an account which was closed, upon 
the assumption that the instrument of credit would be 
met at maturity. This latter theory does not appear to 
have the courage of its convictions; if it is true that the 
nature of the customer’s account was not sufficiently 
altered by the execution of the promissory notes to pre¬ 
clude its being reopened, then it seems that it should not 
have been closed at all. 

Bills Receivable 

The asset account “Notes Receivable” is frequently 
found, in practice, under the name of “Notes and Bills 
Receivable,” and not infrequently under the generic name 
of “Bills Receivable.” So far as accounting is concerned, 
the theory of these two classes of commercial instruments 
does not differ materially; still, there is good reason why 
it might be better to keep separate accounts with them. 

“A bill of exchange,” says Mr. Tompkins in his book, 
“The Law of Commercial Paper,” is an unconditional 
order in writing addressed by one person to another, 


j54 the theory of the asset accounts 

signed by the person giving it, requiring the person to 
whom it is addressed to pay on demand, or at a fixed or 
determinable future time a sum certain in money to order 
or to bearer.” 

t 

Thus a bill of exchange introduces into the relations 
between the proprietor of the business and his customer, 
a third person, the drawee, who, after the bill has been 
presented to him, becomes the acceptor, that is to say, 
the party liable to the payee. This alters the liability of 
the customer to the proprietor of the business; from 
primary it becomes secondary. No such alteration of 
liability is found in a promissory note. 

Whether or not the keeping of separate accounts with 
notes and bills is deemed advisable by a concern whose 
custom it is to receive both classes of instruments, it 
seems that a concern which receives promissory notes 
only, should not permit the use of the term “bills receiv¬ 
able” on its ledger. The very name of the ledger account 
gives misleading information. 

The opinion held upon this subject by W. M. Cole, of 
Harvard University, is quite different from the one ex¬ 
pressed above— 

“The account in which negotiable notes are recorded 
is called ‘Bills Receivable.’ Drafts which have been ac¬ 
cepted by those upon whom they are drawn, are also recorded 
in Bills Receivable; but drafts which have not been accepted 
are not recorded at all on the principal books, for until 
accepted they have no value other than that of any 
written request. It should be noted that Bills Receivable 
has a restricted significance, and does not at all include 
ordinary so-called ‘open accounts’ or ‘book accounts,’ 
i. e., sums owed to a business by customers to whom it has 
sold goods on trust. The term ‘Bills Receivable’ is used 
only of promises to pay, written in the form of promis¬ 
sory notes or of accepted drafts.” 


CHAPTER XVI 


ACCOUNTS WITH GOODS 


Merchandise Account of Trading Concerns 

The original purpose of this account was to gather the 
factors which affected the gross profits on merchandise. 

It will be remembered that when speaking of the prin¬ 
ciples of double-entry bookkeeping,* it was said that in¬ 
coming values greater than the outgoing values which 
they replaced, produced a gain which should be recorded 
in a nominal account. So far as merchandise is concerned, 
this could not be done conveniently, unless the cost of 
every object sold were known by the bookkeeper. If this 
were the case and he were able to furnish the physical 
effort which such bookkeeping would require, his entry 


would be, for every sale: 

Customer (or Cash). $50.00 

To Merchandise. $ 35 -°° 

“ Profit on Merchandise. I 5 -°° 


It was found convenient to credit the goods account 
with the sale price of the goods sold, and, periodically, to 
apply to it the value of the inventory remaining on hand. 
Thus the skeleton of the merchandise account is merely 
this: 


Debits 

Initial inventory 
Purchases of the period 
Gross profit on sales 


Credits 

Sales of the period 
Closing inventory 



* Page 70. 







!66 THE theory of the asset accounts 


But since both goods purchased and goods sold are 
likely to prove unsatisfactory to the buyer, it follows that 
original debits made to the merchandise account are true 
only if none of the goods have been sent back to the ven¬ 
dor; and that original credits are true only if none of the 
goods have been returned by the customer. When goods 
sold are returned, the merchandise account is debited in 
order that the sale may be canceled; and when goods pur¬ 
chased are sent back, the merchandise account is credited 
in order that the purchase may be canceled. At this point, 
the structure of the account is as follows: 


Debits 

Initial inventory 
Purchases of the period 
Returned sales of the period 
Gross profit on sales 


Credits 

Sales of the period 

Returned purchases of the period 

Closing inventory 


Inasmuch as the purpose of the merchandise account 
is to show the true gross profit on sales, it is evident that 
losses due to merchandise being destroyed as unfit to be 
sold, or to deterioration reducing its value, must be ac¬ 
counted for; and it is also plain that unless this is done 
before inventory time, by a credit to the goods and a debit 
to profit and loss, the profit shown by the merchandise 
account will not be the profit on sales, and the profit and 
loss account will fail to convey proper information in re¬ 
gard to extraordinary losses. Thus, the components of 
the merchandise account have become: 


Debits 

Initial inventory 
Purchases of the period 
Returned sales of the period 
Gross profit on sales 


Credits 

Sales of the period 
Returned purchases of the period 
Merchandise destroyed 
Closing inventory 


It has been denied that the merchandise account 
should ever go further than this. On the other hand, it 
has been claimed that if thus restricted it cannot show: 




ACCOUNTS WITH GOODS 


167 


I. On the debit side: 

a. The cost of freight and cartage incurred on 

the goods purchased. 

b. The cost of the freight and cartage on sales, 

which the vendor has agreed to pay in 
order that he might obtain for his goods 
the price recorded by the sales. 

c. The deductions which the vendor has agreed 

to make from the catalogue price, if his 
policy is to record all sales at that price. 

d. The freight and cartage paid by the vendor 

on goods returned to him by customers. 

2 o On the credit side: 

a. The proportion of the freight and cartage in¬ 

ward which applies to goods unsold. 

b. The freight and cartage paid on goods pur¬ 

chased which have been returned to the 
vendors. 

c. The trade discounts which would reduce the 

cost of the goods purchased, in case they 
have been recorded at catalogue price. 


The above components, gathered according to their 
nature, show the structure of the merchandise account to be: 


Debits 

1. Initial inventory 

2. Purchases of the period 

3. Freight and cartage inward on 

purchases 

4. Freight and cartage outward 

on sales 

5. Returned sales 

6. Freight and cartage inward on 

returned sales 

7. Trade discounts on sales 

8. Gross profit on merchandise 


Credits 

1. Sales 

2. Returned purchases 

3. Freight and cartage inward, 

paid at time of purchase, on 
purchases now returned 

4. Trade discounts on purchases 

5. Merchandise destroyed as un¬ 

fit for sale 

5 . Deterioration of merchandise 

7. Freight and cartage inward 

on purchases, applicable to 
goods unsold 

8. Closing inventory 




!68 THE theory of the asset accounts 

Analysis of the Merchandise Account 

Prior to the division of the journal into its components 
(purchases, sales, purchases returned, sales returned, cash, 
etc.) the merchandise account, being posted daily, con¬ 
tained a multitude of unclassified facts which required ex¬ 
tensive analysis in order to show how the gross profit was 
obtained. This is still the case whenever detail posting is 
in vogue. But when books of original entry are so con¬ 
structed as to permit of the monthly gathering of posting 
material, the merchandise account becomes a perfect sum¬ 
mary of trading transactions. As each class of facts is sup¬ 
ported by details to be found in analytical journals, no 
analyses are necessary, and the material for financial state¬ 
ments is obtained by merely adding together the compo¬ 
nents of like nature as found in the accounts for the ac¬ 
counting period. 

Subdivisions of the Merchandise Account 

It has become the fashion to advocate the abandon¬ 
ment of the “old-fashioned merchandise account.” A 
series of “simple” accounts, each one containing one of the 
components of the old account, will, it is claimed, give 
better results without analysis. It must be borne in mind, 
however, that after all the components of the merchandise 
account have been raised to the dignity of individual ac¬ 
counts, they represent nothing more than the monthly 
footings of columns of journals, and that in order to lead 
to a conclusion in regard to the result to which they all 
have contributed in a positive or in a negative way, they 
must be methodically gathered either in a trading ac¬ 
count, or in the profit and loss account. 

The accounts which are to be opened, to satisfy the re¬ 
quirements of this theory, are the very components ex¬ 
pressed in the foregoing, in connection with the merchandise 


ACCOUNTS WITH GOODS ^9 

account. Their accounting treatment at the end of the 
period is expressed by journal entries as follows: 

Freight and Cartage Inward on Purchases Returned $. 

To Freight and Cartage Inward on Purchases $. 

To reduce the latter account to the amount of the 
uncanceled transaction. 

Freight and Cartage Inward applicable to subsequent 

periods. $. 

To Freight and Cartage Inward on Purchases $.„ 

To set up as a deferred debit item the portion of 
freight applicable to future sales. 

Returned Purchases cf Trading Merchandise. $. 

To Purchases of Trading Merchandise. $.. 

To reduce the latter account to the amount of the 
uncanceled transactions. 

Inventory of Trading Merchandise. 

To Purchases of Trading Merchandise. $. 

For portion of purchases of the period, not sold, 
and still held as an asset. 

Trade Discounts on Purchases of Trading Mer¬ 
chandise . $. 

To Purchases of Trading Merchandise . $. 

To deduct from cost of purchases the price list de¬ 
duction to which we are entitled. 

Profit and Loss. $. 

To Purchases of Trading Merchandise. $. 

“ Freight and Cartage Inward on Purchases. . 

To close in the summary account the purchase 
cost of the goods sold, and the additional cost 
of handling. 

Sales of Trading Merchandise. $. 

To Returned Sales of Trading Merchandise.. $. 

To reduce the former account to the amount of 
the uncanceled transactions. 

Sales of Trading Merchandise. $. 

To Trade Discounts on Sales. $. 

To deduct from the income from sales the price 
list deduction to which our jobbers are entitled. 

Sales of Trading Merchandise. $. 

To Profit and Loss. $. 

To close in the summary account the gross in¬ 
come obtained from sales. 



































THE THEORY OF THE ASSET ACCOUNTS 


170 


Profit and Loss. $. 

To Freight and Cartage Outward on Sales of 

Trading Merchandise. $. 

For cost of forwarding to f. o. b. points, according 
to agreement with customers. 

Profit and Loss. $. 

To Trading Merchandise Unfit for Sale. $. 

“ Deteriorated Trading Merchandise. . 

For loss of capital having no relation with pur¬ 
chases and sales, but connected with trading 
merchandise. 

As a result of the above entries, the Profit and Loss 
account will exhibit the following skeleton : 

Profit and Loss 


• • • • • 


Sales of Trading Mer¬ 
chandise . $. 


1. Cost of Purchase of 

Merchandise Sold: 

a. Cost of Purchases 

Sold . $ 

b. Cost of Handling, 

Inward. 

2. Freight and Cartage 

Outward on Sales... 

3. Merchandise Unfit for 

Sale . 

4. Deteriorated Trading 

Merchandise . 


The gross profit on merchandise results from the deduc¬ 
tion of the above debits 1 and 2, from the only credit con¬ 
tained in the account. 

It is pointed out that whether the gathering of merchan¬ 
dise components is done monthly in the merchandise account, 
or only at the end of a period, in the Profit and Loss account, 
makes no difference whatever. Since one of the main ob¬ 
jects of accounting is so to gather financial facts that it will 
be possible readily to obtain financial statements, it must be 
admitted that complex accounts posted from analytical books 
of original entry are equally as satisfactory as simple ac¬ 
counts which are supposed to render the ledger analytical. 






















ACCOUNTS WITH GOODS 


171 

Inventory of Trading Merchandise 

The inventory of a trading concern should be valued 
at cost. It has been held that it is proper to compute it 
on the basis of the market value, if such a value is smaller 
than cost; but it is generally denied that a market value 
higher than cost can be used. If the lower value is al¬ 
lowed, there is no reason why the higher one should not 
be. There is, however, a good reason why market values 
should not be used at all. Accounting is not interested in 
what would have happened “if,” but in what has actually 
happened; and since the goods unsold were purchased at 
a certain price, the profits realized are to be measured by 
comparing that price with the proceeds. To reduce the 
inventory to a value lower than cost, is to add to the cost 
of the goods sold during the period; and to raise the in¬ 
ventory to a value greater than cost, is to reduce the cost 
of the goods during the period. In either case, the result 
is contrary to the truth. 

The taking of a physical inventory at the end of every 
accounting period is customary with all trading concerns 
selling goods which are subject to shrinkage, to deteriora¬ 
tion by exposure, to thefts, or to errors in weighing at 
time of purchase and of sale. When, however, these con¬ 
ditions are not present, it is not unusual to find that a 
book inventory is considered quite satisfactory. In such 
cases, the purchases of merchandise are entered by classes 
of goods, in a “merchandise stock book” showing, on the 
debit side, the quantities purchased, their cost per unit, 
and their money value; in the credit column, the quanti¬ 
ties sold, their cost per unit, and the money value of the 
sales, an average being established if the occasion arises; 
in the balance column, the quantities remaining, their cost 
per unit, and their money value, and, if prices are sub¬ 
ject to fluctuations, or have fluctuated, the average cost and 
money value. (See Figure 32.) 


172 


THE THEORY OF THE ASSET ACCOUNTS 



Figure 32. Merchandise Stock Ledger 






































































































ACCOUNTS WITH GOODS 


173 


Merchandise Accounts of Manufacturing Concerns 

Traders sell their goods in the shape in which they 
purchase them; manufacturers sell “finished goods” 
which have undergone a “manufacturing process” in the 
course of which labor has been expended, materials and 
supplies consumed, and expenses incurred. Thus, so far 
as the goods are concerned, there are three distinct 
stages: 

1. The stage when they are in their raw state 

2. The stage when they are “in process” (or in 

“progress”) 

3. The stage when they are “finished” 


As they pass from stage to stage, the goods accumu¬ 
late cost, until, upon completion, they stand precisely in 
the same relation to the manufacturer as trading goods 
do to the trader. Thus, it may be said that the “Finished 
Goods” account is the “Merchandise” account of the 
manufacturer, built up from its sundry components: 


Debits 

Initial inventory 

Cost of goods finished during the 
period 

Returned sales 
Gross profit on sales 


Credits 

Sales 

Closing inventory 


As to the elements of cost which the goods manufac¬ 
tured accumulate while passing from stage to stage, they 
may be briefly stated as follows: 

j. Raw Material Stage (Ledger Account: <e Raw Ma¬ 
terials”) : 

a. The cost of purchase of materials and supplies 

b. The cost of freight and cartage inward thereon 

c. The cost of handling and storing them 

The last two items have sometimes been referred 
to as “Pre-Process Cost.” 



X74 THE theory of the asset accounts 

2. Goods in Process Stage (Ledger Account: “Goods in 
Process”): 

a. Cost of raw materials transferred from stores 

b. Productive labor, that is to say, the skilled labor 

which produces the finished goods, and can be 
allocated: 

(1) To the product at large if only one class of 

goods is manufactured 

(2) To individual units of production if several 

classes of goods are manufactured 

(3) To job numbers in either case 

This labor is consumed for the production of the 
manufactured goods only, and has nothing to 
do with the other phases of the activities of the 
factory. 

c. Manufacturing burden (also called manufacturing 

overhead), that is to say, the expenses incurred 
in connection with the operations of the factory, 
which, while part of the cost of manufacture, 
cannot be allocated to any given unit of the 
production, and must be apportioned thereto on 
some scientific basis. It includes: 

(1) Unproductive labor : 

(a) Superintendence and supervision, in¬ 

cluding the salaries of the superin¬ 
tendent, and of his assistants, and 
the wages of the foremen. 

(b) All the unskilled labor which, while not 

directly expended on the manufac¬ 
tured product, is necessary and 
beneficial thereto, or is required in 
order that the factory may continue 
as an organized body. 


ACCOUNTS WITH GOODS 


I 75 


(2) Factory expenses, such as fuel, light, power, 
rent, sundry supplies, repairs to machinery 
and tools, tools consumed as a result of 
operations, and, if operating reserves are 
considered better than surplus appropria¬ 
tions, the estimated depreciation of machin¬ 
ery and tools. 

d. General factory burden (also called general fac¬ 
tory overhead). When the organization of the 
factory is such that it is run as a distinct de¬ 
partment, any expense which is called for by 
that very organization, such, for instance, as the 
keeping of factory records, the cost of station¬ 
ery and printing, the estimated depreciation of 
the factory buildings and factory building equip¬ 
ment, etc., must be apportioned to the cost of 
the goods in process. 

Finished Goods Stage (Ledger Account: (C Finished 

Goods”): 

a. When goods have passed through the “process’' 
stage, and are ready for sale, their cost is cred¬ 
ited to the account “Goods in Process,” and 
debited to the account “Finished Goods.” At 
this point, we really have a manufactured mer¬ 
chandise account, which differs from the trad¬ 
ing merchandise account, only in that the latter 
shows every unit of its mechanism, while the 
Finished Goods account receives from an inter¬ 
mediary, a unit composed of: 

( 1 ) Purchase cost of goods ready to be sold, 
including the following components of 
the merchandise account: 

(a) Initial inventory of goods purchased 

(b) Purchases of the period 


THE THEORY OF THE ASSET ACCOUNTS 

(c) Freight and additional cost of 

goods purchased 
Less: 

(d) Closing inventory of goods pur¬ 

chased, inflated by additional cost 
applicable thereto 

(2) Manufacturing cost of goods purchased 
and made ready to be sold 

The components of the Finished Goods account are: 


Debits 

Initial inventory of goods finished 
and unsold during the prior 
period 

Cost of goods manufactured dur¬ 
ing the present period 
Returned sales 
Allowances on sales 
Trade discounts 
Gross manufacturing profit 


Credits 

Sales 

Closing inventory 


If the system of bookkeeping which has been adopted, 
provides for separate accounts for sales and for the trans¬ 
actions incident thereto, the Finished Goods account is 
reduced to the functions of a species of Inventory ac¬ 
count, of which the following are the components: 


Debits 

Initial inventory 

Cost of goods manufactured dur¬ 
ing the period 


Credits 

Closing inventory 
Cost of manufactured goods sold 
(debited to profit and loss or to 
a group account “Cost of Goods 
Sold,” which is, in turn, closed 
into the Profit and Loss ac¬ 
count) 


Inventories of the Merchandise Accounts of Manufacturing 
Concerns 

At the close of the accounting period, the valuation of 
inventories of raw materials, sundry supplies, goods in 




ACCOUNTS WITH GOODS 


177 


process, and finished goods, presents serious difficulties, 
unless the cost system of the concern is sufficiently de¬ 
veloped to give positive and ready data concerning the 
manufacturing process. 

Inventory of Raw Materials and Sundry Supplies 

If, in connection with the raw materials and the sun¬ 
dry supplies, there is kept a stock ledger (Figure 33), a 
book inventory may be obtained which will check the 
accuracy of the physical inventory, or which may even be 
allowed to take its place. The stock ledger is so arranged 
that it contains an account with each class of merchandise. 
Individual accounts are debited with the quantity, the 
cost per unit, and the total money value of the initial in¬ 
ventory (if any) and of the purchases of the period; and 
credited with the quantity, cost per unit, and money value 
of the material which goes out upon requisitions. In¬ 
formation is supplied also as to the destination of the out¬ 
going material. The difference between the debits and 
credits gives the quantity and money value of the goods 
remaining in store; it also gives the cost per unit if the 
units have been acquired at a uniform figure. In the con- 
trary case, the average cost price must be obtained as well 
for the amount of the goods remaining on hand as for 
the value of the goods requisitioned for factory or other 
purposes. If no stock ledger is kept, a physical inventory 
is essential, the pricing of which will have to be established 
by reference to the purchase invoices of the period. The 
process will be not only lengthy, but inaccurate, unless a 
great deal of care is exercised. 

It will be noticed that the example submitted affords 
useful information to the purchasing agent, in that it in¬ 
dicates the exact quantity of material ordered which has 
not as yet been received at inventory time, or at any other 
time. It also gives, under the heading ‘‘General Order 


Ijg THE THEORY OF THE ASSET ACCOUNTS 



Figure jj. Stock Ledger 















































































































ACCOUNTS WITH GOODS 


179 

No.”: the quantity and the amount of material which has 
been consumed for purposes other than for manufacture, 
such as repairs and maintenance, additions to plant, etc. 

Inventory of Goods in Process 

If the concern has an adequate system of cost account- 
ing - , the recapitulation of the cost sheets (Figure 34) estab¬ 
lished for job numbers or for stock numbers (or for both) 
still in progress, will give the inventory value of the asset 
goods in process/ provided it is customary to apply the 
overhead burden of a period to the processes of that 
period. If the custom is to apply the burden to finished 
goods only, either the pricing of the inventory of 
“goods in process” will have to take into consideration, 
subject to a subsequent reversal of the entry, the propor¬ 
tion of the burden applicable to the goods when com¬ 
pleted; or there will have to be created a special account 
which will contain the said burden, in order that it may be 
withheld from the cost of operations, and shown in the 
balance sheet as a deferred debit to cost of goods under¬ 
going process of manufacture. 

With minor alterations in the descriptive and statisti¬ 
cal part thereof, Figure 34 can be used for factories which 
operate on job numbers. 

Inventory of Finished Goods 

Under a proper cost finding and cost recording system, 
the valuation of the inventory of finished goods is estab¬ 
lished precisely like that of goods in process, by recapitu¬ 
lating the cost sheets relating to the job (or stock) num¬ 
bers which have not been sold during the period. 

Inventory When There Is No Cost System 

If there is no cost system, the valuation of the inven¬ 
tories of goods in process and of finished goods will have 


i 8 o 


THE THEORY OF THE ASSET ACCOUNTS 


H 

UJ 

LU 

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JX. 

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.<0 

<n 

tS 







18 

1 

1 

f 

Amount 




















<0 

‘55 

(0 

CQ 



' 




Productive Labor 

Amount 













£ 

IS 







i 






1 

Paw Materials 

Amount 












1 

Price 







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t 

8 

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Description 







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3 0 6 



















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p cr 

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Figure 34. Cost Sheet 


































































































































ACCOUNTS WITH GOODS 


181 


to be established by what might be called the “dead- 
reckoning” method. A satisfactory basis will have to 
be found for the application of labor and overhead ex¬ 
penses to the material represented by the two classes of 
goods. Under these conditions, it is evident that no ac¬ 
countant is in a position to pass upon the accuracy of the 
figures submitted. His task, however, instead of being 
lightened by this exemption from responsibility, will be 
materially increased owing to the difficult character of 
the periodical adjustments to be made in order that the 
general books may support the financial statements which 
he will submit. 

The inventory of raw materials and sundry supplies, 
when applied to the net debit of the general ledger ac¬ 
count therefor, will give the consumption of materials and 
supplies during the period, either for manufacturing pur¬ 
poses, or for the general purposes of the plant. The divid¬ 
ing line between these two classes of facts will be given by 
an analysis of all the available factory records and 
memoranda which may throw any light whatever on the 
subject. The amount used for manufacturing purposes 
will be transferred to the debit of a ledger account 
“Goods in Process” raised for the purpose of obtaining 
the cost of the goods put in progress during the period, 
while the amount used for the plant will be debited to the 
different accounts with subdivisions of the plant, or to 
Repairs and Maintenance account. To the account “Goods 
in Process” will be debited separately: 

1. The productive labor 

2. The factory manufacturing overhead 

3. The factory general overhead 

applicable thereto, as ascertained from analyses of the 
pay-roll and other records, and from the classification of 
the nominal factors disclosed by the general books or by 


lS2 THE theory of the asset accounts 


analyses thereof, and as distinguished from the propor¬ 
tion of these items which is to be charged to capital ac¬ 
counts or to repairs and maintenance accounts. At this 
point, the account “Goods in Process” will contain the 
total cost of the manufacturing activities of the factory 
for the whole period. 

It will now be necessary to credit the account, and to 
debit Finished Goods, with the difference between the 
total value of the individual items i, 2, and 3, and material, 
and the amount thereof said to be applicable to the goods 
unfinished and still on hand at the end of the period. 

The balance remaining in the account “Goods in 
Process,” will be the inventorial value of that asset. 

The last step will be to credit the Finished Goods ac¬ 
count with the value of an inventory which will be estab¬ 
lished by adding to raw material value of goods on hand, a 
proper proportion of productive labor, and a proper pro¬ 
portion of the two classes of factory burden. The balance 
of the account will be transferred direct to Profit and Loss, 
or to an intermediate account “Cost of Goods Manufac¬ 
tured and Sold,” which will in turn be transferred to the 
Profit and Loss account and opposed to the sales in order 
that the gross profit may be known. 

Apportionment of Overhead Expenses 

The application of overhead expense, at inventory 
time, to quantities remaining in process, reveals the im¬ 
portance of the subject of distribution, and raises, 
naturally, the question of the basis for such distribution. 

1. Labor Rates 

It is claimed by some accountants that a satisfactory 
basis is found in the division of the total of each class of 
overhead (or of the two classes together), bv the total 
amount of productive labor consumed during the period. 


ACCOUNTS WITH GOODS 


183 

This, they say, gives the rate to be used in the distribu¬ 
tion of overhead, to jobs, to orders, or to general classes 
of goods manufactured. Others maintain that this basis 
will be moderately accurate, only if the operators relate to 
a single class of product, and if the quantity produced is 
practically the same from month to month. They suggest 
that a more accurate application of the burden could be 
made on the basis of the ratio which the annual total bur¬ 
den bears to the annual total hours of direct labor con¬ 
sumed by each class of goods, or each job number or order 
number. 

2. Machine Rates 

There are still others who claim that while productive 
labor has been, up to modern times, the essential and prob¬ 
ably the basic factor of cost, it has so far ceased to be so 
in these days of machinery as to practically eliminate the 
element of human skill from the work performed by the 
so-called “productive laborers. ” They suggest the 
“machine rate” as the only satisfactory basis on which to 
apply overhead expenses. This means that the burden is 
to be distributed on the basis of the ratio that it bears to 
the total number of hours of work produced by the oper¬ 
ating machines. 

Going still further, some claim that neither basis will 
be effective if applied to the manufacturing as a whole, but 
that both may work well when applied to each and every 
department of the factory subdivided into as many de¬ 
partments as there are phases of the process. 

To continue the nomenclature of distribution bases 
we may mention the “material” rate, the “labor and ma¬ 
terial” rate, and the “old machine” rate, the “new ma¬ 
chine” rate, and the “pay” rate. 

The “new machine” rate is especially interesting be¬ 
cause it attempts to accumulate upon the machines which 


T g4 THE THEORY OF THE ASSET ACCOUNTS 

produce the goods in a particular department, the total 
cost of operations of that department, including all labor; 
and thus, it is possible to obtain the hour cost of operat¬ 
ing a machine. The manufacturing cost of the goods pro¬ 
duced in a department is then found by multiplying the 
machine hours required for the production of the goods, by 
the cost of the machine hour. 

The Problem of Expense Distribution 

Whatever may be the views of accountants upon the 
matter of expense distribution, “production and effi¬ 
ciency” engineers scorn them. Hamilton Church says in 
his book on “Production Factors in Cost Accounting and 
Works Management”: 

“The error which dominates and vitiates all the usual 
and popular methods of dealing with indirect expense is 
simply ‘analysis/ This is the rock on which they all founder. 
For the purposes of the accountant this analysis is suffi¬ 
cient, because the accountant is concerned neither with 
the efficiency nor with the improvement of production. 

“It does not matter greatly to him whether a particu¬ 
lar item of expense is due to inefficient power distribution, 
or to worn-out machinery, or to buildings imperfectly 
adapted to their uses. To him an expense is an expense; 
but to the production engineer it may be more than an ex¬ 
pense—it may be a revelation. Yet, as long as we persist 
in looking on all the activity and all the expenditure go¬ 
ing on in and about a works as due to production, so 
long will the accountant’s point of view necessarily hold 
the field. As long as we shut our eyes to the fact that 
actual production is the last organization in a chain of 
separate organizations, so long will the present confused 
ideas about indirect expenses or establishment charges 
hold their ground unshaken.” 

It is not the intention to enter into a discussion of 



ACCOUNTS WITH GOODS 


185 


cost accounting, or, as it has been termed of late “cost 
finding.” This branch of accounting is far too extensive 
to permit of its being even sketched in the present volume. 
Be it sufficient to state that articles are published almost 
daily on the application of factory overhead, and that the 
subject deserves the special attention of the student who 
has mastered the principles of accounting. 


CHAPTER XVII 


CONSIGNMENTS—SHIPMENTS INWARD 

Relations of Consignor and Consignee 

While the subject of consignments, from the point of 
view of modern business practice, is far less important to¬ 
day than it was fifty or sixty years ago, it has lost none of 
its importance from the viewpoint of the accountant, 
since it gives rise to the difficult problems of agency ac¬ 
counting. 

So far as the consignee is concerned, he may be: 

1. A ‘‘factor,” otherwise known as a “commission 

merchant,” whose business consists in selling 
merchandise belonging to others in considera¬ 
tion of a “factorage” or “commission” agreed 
upon. 

2. An individual or concern engaged in any line of 

business, whose facilities for selling in a desir¬ 
able market make it profitable to engage him or 
it occasionally to act as a factor in return for 
proper compensation. 

Consignments made to either class of consignees estab¬ 
lish, between the parties, the relation of principal and agent. 
There is, however, this difference: certain states of the 
Union license regular factors and bond them, whereas no 
state requires either bond or license from an occasional 
consignee. 

186 


CONSIGNMENTS—SHIPMENTS INWARD 


187 


Consignee’s Duties and Liabilities 

The factor (or commission merchant) and the occa¬ 
sional consignee (or correspondent) owe the principal for 
whom they act as agents, such ordinary care of consigned 
goods as a prudent person would take of property in¬ 
trusted to him. They are not liable for losses due to 
causes over which they could not, in reason, be expected 
to have control; but they are liable for all losses due to 
their failure to carry out instructions which they have re¬ 
ceived from their principals.* 

Factors may act under specific or under general in¬ 
structions. In the first instance, they must sell at the 
price fixed by the consignor; in the second instance, they 
must sell at the highest price obtainable, and exert due 
diligence to that end. The term “due diligence” is not 
understood to include foresight in connection with sudden 
fluctuations of prices. If the agreement entered into is 
to the effect that the goods will be sold at no less than a 
certain price, a sale by the consignee at less than the said 
price is in the nature of a violation of specific instructions, 
and makes him liable for the difference. 

In the absence of specific instructions to the contrary, 
a factor may sell on credit; if he does so, and exercises 
proper diligence in ascertaining the financial responsi¬ 
bility of purchasers, he is not liable for losses due to their 
subsequent failure. What is still more important to the 
accountant, the factor is not liable to his principal for the 
money value of sales until he has collected the amount 
due thereunder. This rule, however, does not apply where 
the factor has lacked prudence in giving credit; or where 
he has been negligent in attending to collections; and, 
lastly, where he operates under the provision of a “del 
credere” agreement, that is to say, when he has agreed, in 

* Scott v. Rogers, 31 N. Y. 676, holds that a consignee who had received in- 
structions to sell goods o*i a certain day at a specific price, or to ship them to a 
ce/tain place, and had done neither, was guilty of a conversion of the goods. 



x gg THE THEORY OF THE ASSET ACCOUNTS 

consideration of a higher commission, to hold himself re¬ 
sponsible for the proceeds of all sales made by him as 
agent. 

If the consignee is under specific instructions to sell 
for cash, or on credit upon the pledge of security, he is 
liable for all losses due to his failure to comply. 

A consignee may incur, for the account of his prin¬ 
cipal, such expenses as are necessary for the protection of 
the merchandise consigned to him, and such losses or al¬ 
lowances as are necessary to the validity of his sales. His 
doing either or both, creates in his favor a lien on the 
goods, similar to the one which he obtains by making ad¬ 
vances to his principal. The lien for expenses extends to 
customs duties, marine and fire insurance, freight and cart¬ 
age, storage, weighing, handling, packing, unpacking, etc. 
The lien for losses extends to allowances for defective 
goods, shortages in weight, faulty packing, etc. 

The question of advances by the consignee to the con¬ 
signor is all the more important, because some legal 
authorities hold that advances give the factor the right 
to sell enough of the consigned goods to satisfy his claim. 
Even when selling for advances, however, some of the 
authorities hold that he is bound to obey his instructions 
regarding the price at which the goods should be sold. 

The consignee has no right to pledge as his own, goods 
received by him on consignment. But if he has made ad¬ 
vances to his principals, he may, in order to secure his own 
debts, deposit an amount of goods equivalent to his ad¬ 
vances, provided he gives the third party due notice that 
the goods are merely liened to him, and not owned by 
him.* 

Unless the instructions received by the factor ex¬ 
pressly forbid him to do so, he may accept promissory 


♦ 37 - 


* Urquhart v. Mclver, 4 Johns (N. Y.) 103; Silverman v. Bush, 16 Ill. App 



CONSIGNMENTS—SHIPMENTS INWARD 


189 

notes in settlement of consigned goods sold; if he has duly 
ascertained the standing of the maker of the note at the 
time of its execution, and has not discounted the note 
for his own use, he is not liable for the dishonor of the 
instrument, due to a subsequent failure of the maker. 

The acceptance of consignments by a factor, makes it 
imperative for him to comply with such disposition of the 
proceeds as his principals may wish to make. If money 
is due his principals he cannot refuse to accept a draft 
drawn by them to the order of a third party, provided he 
has notice of the draft. 

Unless specific provisions to that effect exist in the 
agreement between the principal and the factor, or unless 
such a provision can be implied, either from the contract 
or from custom, the factor is not chargeable with inter¬ 
est except when he fails to render account at the proper 
time, and to remit when he should do so. 

The Factor’s Accounts and Accounting 

Under this general heading, the Cyclopaedia of Law 
and Procedure says of factors:* 

“The factor must account to his principals for goods 
sold * * * he must, when reasonably requested, present 
to his principal a full, complete, and specific account of his 
dealings between themselves, and between the factor and 
the purchasers. It is held that it is the factor’s duty to 
be prompt in rendering an account of his sales, whether 
requested to do so or not, and that a failure to render an 
account for an unreasonable time will render him liable, 
especially where a demand is impracticable or highly in¬ 
convenient. That he may render a satisfactory account, 
it is his duty to keep books in which are entered correct 
accounts of his transactions, and the books should be 
subject to the principal’s inspection, and the principal is 


* Cyc., Vol. XIX, p. 135- 



I9 0 THE theory of the asset accounts 

entitled to a correct copy of the entries in the books, in¬ 
cluding all memoranda connected therewith. Accounts 
current are necessarily provisional until settled, and even 
after settlement may be rectified for errors and omissions, 
subject to which every settlement is made; but if the fac¬ 
tor render his account in good faith, and the principal 
makes no objection to it, the principal's assent to it as 
correct is presumed; and unless objection is made within 
reasonable time his principal will be bound by the ac¬ 
counting rendered.” 

Francis B. Tiffany, in his “Handbook of the Law of 
Principal and Agent,” says of the agent’s duty to 
account: 

“It is the duty of the agent to account to the principal 
for all the money and property coming into his hands by 
virtue of his employment, including all profits resulting 
from the transactions, either as agent, or on his own ac¬ 
count in breach of his duty as agent. 

“His specific duties in this respect are: 

1. To keep accounts of all his transactions in the 

course of the agency, and to render his accounts 
whenever required by the terms of his employ¬ 
ment, or upon demand. 

2. To keep money and property of the principal sepa¬ 

rate from his own, and from those of third per¬ 
sons. 

3. To pay or deliver to the principal all money and 

property of the principal coming into his hands 
as agent, whether required by the terms of the 
employment, or upon demand.” 

Books of the Factor 

The foregoing remarks concerning the rights, duties, 
and privileges of the factor, commission merchant, or con- 


CONSIGNMENTS—SHIPMENTS INWARD 


191 

signee, appear to leave him no choice but to make his ac¬ 
counting comply with the spirit of the statutes. As to the 
accounting method which he will adopt, he may choose 
between two distinct treatments: 

1. He may record in his own general books all the 

transactions affecting consignments, in such a 
manner as to keep what he owns and what he 
owes as a business man separate from that 
which he holds as factor, and for which he is 
accountable to his principals. 

2. He may record in special agency books, all the 

transactions affecting consignments, and periodi¬ 
cally transfer to his own books the results of his 
activities as factor, in so far as they have affected 
his assets, his liabilities, and his income. 

Books of the Factor—Agency Accounts Kept in General 
Books 

Since one of the accounting duties of the factor is to 
keep the money and the property of his principal sepa¬ 
rate from his own, and from those of third persons, it fol¬ 
lows that, if he keeps only one set of books, he must: 

1. Open a separate account with each consignment 

and with each consignor. 

2. Keep a separate bank account for each individual 

consignor, and one for himself. 

3. Record separately purchases and sales of, and 

profits on, merchandise traded in by him on his 
own account. 

4. Separate the accounts of his own customers from 

those of the customers of his principals, and 
keep separate controlling accounts with the cus¬ 
tomers of each consignor. 


192 


THE THEORY OF THE ASSET ACCOUNTS 


5. So plan his books of account, that they will differ¬ 
entiate: 

a. The factor’s own assets, and the assets of 
his individual principals, the latter includ¬ 
ing: 

(1) The goods held on consignment, re¬ 

corded at their consigned value. 

(2) The cash deposited in his name, but as 

agent for his individual principals, 
and, if conditions warrant, the un¬ 
settled consignments, customers’ bal¬ 
ances, and unmatured promissory 
notes receivable. 

0. The factor’s own liabilities, and the credit ac¬ 
counts necessary to counterbalance the prin¬ 
cipals' assets held by him; these credit ac¬ 
counts, which are merely contras of the prin¬ 
cipals’ unrealized assets, or represent matur¬ 
ing liabilities to the extent of the realized 
assets, comprise: 

(1) The contra of the consigned goods ac¬ 

count, that is to say, the consignor’s 
individual goods account. 

(2) The consignor’s individual account cur¬ 

rent containing the proceeds of the 
sales, less the charges made by the 
factor for advances or expenses, or 
both and for commissions. 

Thus, a theoretical trial balance, before the closing 
of the general ledger of the factor whose books have 
been kept according to the above described method, might 
be: 


CONSIGNMENTS—SHIPMENTS INWARD 


193 


Trial Balance 


Of the books of John Harrison, Commission Merchant 

(Before Closing) 


Furniture and Fixtures 


Creditors—J. Harrison.. 

$ 1,561.50 

—J. Harrison. 

$ 3,000.00 

Notes Payable—J. Har- 


General Cash—J. Harri- 


rison . 

750.00 

son. 

1,650.00 

Sales—J. Harrison. 

7,000.00 

Customers—J. Harrison. 

725.50 

Commissions—J. Harri- 


Allowances to Customers 

son. 

551.40 

—J. Harrison. 

25.00 

Capital—J. Harrison.... 

3,499.00 

Merchandise—J. Harri- 




son. 

5,000.00 



General Expense — J. 




Harrison . 

300.00 



$10,700.50 

$13,361.90 

Consignment No. 1. 

$ 4,000.00 

Consignor No. 1—Goods 

“ No. 2. 

3,500.00 

Account . 

$ 4,000.00 

“ No. 3. 

1,660.00 

Consignor No. 2—Goods 

Cash—J. H., Agent— 


Account . 

3,500.00 

Account No. 1. 

4,015.00 

Consignor No. 3—Goods 

“ No. 2. 

340.00 

Account. 

1,660.00 

“ No. 3. 

509.00 

Consignor No. 1—Ac- 


Promissory Notes—Con- 


count Current.(a) 

1,613.50 

signor No. 3. 

150.00 

Consignor No. 2—Ac- 


Customers — Consignor 

count Current.(b) 

196.00 

Nn ?. 

500.00 

Consignor No. 3—Ac- 



count Current.(c) 

1,043.10 

$14,674.00 

$12,012.60 

Total Debits. 

$ 25 , 374.50 

Total Credits. 

$ 25 , 374.50 


(a) Charged with commissions of $401.50, and with advances of $2,000.00 

(b) “ “ “ “ 34.00, “ “ expenses “ 110.00 

(c) “ “ “ “ 115.90 


$ 551.40 


$2,110.00 










































T 94 


THE THEORY OF THE ASSET ACCOUNTS 


It will be noticed that the difference between the 
assets of his principals, held by John Harrison, and the 
credit accounts which he has created to offset them or to 
reflect his accountability therefor, is precisely the amount 
of the commission, advances, and expenses, charged by 
him to the individual account current of the consignor 
liable therefor. We shall shortly see what accounting 
steps the factor must take to close his books, and to ad¬ 
just his own assets, as well as the assets of his principals: 
let us now express in concrete form the journal entries 
made by him so far as consignments are concerned, dur¬ 
ing the period which is about to close: 


I. Debit: 

Individual consignment ac¬ 
counts 

Credit: 

Individual consignors’ goods 
accounts 


with the consigned 
value of the goods 
received. 


2. 


Debit: 

Individual consignors’ goods 
accounts 
Credit: 

Individual consignment ac¬ 
counts 


with the consigned 
- value of the goods 
sold. 


3. Debit: 

Individual consignors’ cash 
accounts (or promissory 
notes receivable, or con¬ 
signment customers’ con- - 
trolling accounts) 


with the sale price 
of the goods sold. 


Credit: 

Individual consignors’ ac¬ 
counts current 






CONSIGNMENTS—SHIPMENTS INWARD 


195 


4- 


Debit: 

Individual consignment ac¬ 
counts 

Credit: 

Individual consignors’ goods 
accounts 


with the consigned 
value of sales re¬ 
turned. 


5. Debit: 

Individual consignors’ 
counts current 

Credit: 

Individual consignors’ 
tomers’ controlling 
counts 


ac- 


with the sale price 
of the goods sold, 
now returned.* 


ac- 


J 


6 . 


Debit: 

Individual consignors’ ac¬ 
counts current 

Credit: 

a. Factor’s cash account, or 

creditors’ accounts or 
both 

b. Factor’s commission account 


with advances made 
to, and expenses 
paid and incurred 
for the account of 
the principal, and 
with the commis¬ 
sion earned on the 
sale of his goods. 


7. Debit: 

a. Individual consignors’ cash 

accounts or promissory 
notes receivable 

b. Individual consignors’ ac¬ 

counts current 

Credit: 

Individual consignors’ cus¬ 
tomers’ controlling ac¬ 
counts 


a. with settlements 
made by customers. 

b. with allowances 
and rebates made by 
the factor in accord¬ 
ance with his in¬ 
structions. 


* In connection with the return of cash sales credit the individual consignor’s 
eash account with the amount of the refund. 









! 9 6 THE THEORY OF THE ASSET ACCOUNTS 


8. Debit: 

Individual consignors’ 
counts current 

Credit: 

Individual consignors’ 
accounts 


with the cash re- 
ac_ mittances made by 
the factor, or with 
the disposition of 
cash the cash proceeds as 
per instructions. 


Passing now to the closing of the factor’s books, let 
us assume: 

1. That the inventory of his own merchandise shows 

a value of $1,500. 

2. That the end of his accounting period corresponds 

with the time at which he must account to his 
principals, and remit the cash proceeds of the 
sales, there being in his agreement with them 
no specification as to his being liable for un¬ 
collected proceeds of sales. 


The expression in journal form of the entries which he 
will have to make to adjust his own accounts is: 


First Entry: 

Merchandise, New Account, J. H.$1,500.00 

To Merchandise, Old Account, J. H. $1,500.00 


To set up the inventorial value of my trading 


merchandise, as per inventory of. 

Second Entry: 

Profit and Loss.$3,825.00 

To Merchandise, Old Account, J. H. $3,500.00 

“ Allowance to Customers, J. H. 25.00 

“ General Expense, J. H. 300.00 


To close into profit and loss, the cost of the 
trading goods sold by me for my own ac¬ 
count, and my expenses and losses of the 
period. 










CONSIGNMENTS—SHIPMENTS INWARD 


19 7 


Third Entry: 

Sales, J. H.$7,000.00 

Commissions, J. H. 551.40 

To Profit and Loss. $7,551.40 

To close into profit and loss income obtained 
by me on the sales of my own trading mer¬ 
chandise, and the commissions which I have 
earned as factor, as follows: 


Consignor No. 1.$401.50 

Consignor No. 2. 34.00 

Consignor No. 3. 115.90 


Fourth Entry: 


General Cash, J. H.$2,661.40 

To Cash, J. H., Agent, Account No. 1. $2,401.50 

“ “ << << << a 

2 . 144.00 

« tt tt it tt is __ 

3 . H5-90 


For checks drawn to my order, in settlement 
of: 


a. My advances to Consignor No. 


1 .$2,000.00 

b. Expenses paid for the account 

of Consignor No. 2. 110.00 

c. Commissions on sales: 

Consignor No. 1.$401.50 

Consignor No. 2. 34.00 

Consignor No. 3. 115.90 551.40 


The expression in journal form, of the entries neces¬ 
sary to adjust the accounts of the principals, is: 


Consignor No. 1, Account Current. 

tt it ^ it it 

. 

a a _ €€ u 

09 .. • 

To Cash, J. H., Agent, Account No. 1 

tt u tt tt tt a ^ 

a tt tt tt tt tt ~ 


$ 1 , 613.50 

I96.OO 

393-10 


$1,613.50 

I96.OO 

393.10 


For remittance to my principals, of the pro¬ 
ceeds of the cash sales of the goods con¬ 
signed to them, in accordance with the terms 
of my employment as factor. 


At this point the trial balance of the factor’s ledger 
will show: 
























igS the theory of the asset accounts 


Trial Balance 

Of the books of John Harrison, Commission Merchant 

(After Closing) 


Furniture and Fixtures 

—J. Harrison.$ 3,000.00 

General Cash—J. Harri¬ 
son . 4,311.40 

Customers—J. Harrison. 725.50 

Merchandise — J. Harri¬ 
son . 1,500.00 

$ 9 , 536.90 


Consignment No. 1.$ 4,000.00 

“ 2. 3,500.00 

“ 3. 1,660.00 

Promissory Notes—Con¬ 
signor No. 3. 150.00 

Customers — Consignor 
No. 3. 500.00 

$ 9,810.00 

Total Debits.$19,346.90 


Creditors—J. Harrison..$ 1,561.50 
Notes Payable—J. Har¬ 


rison . 750.00 

Profit and Loss—J. Har¬ 
rison . 3,726.40 

Capital—J. Harrison.... 3,499.00 


$ 9 , 536.90 


Consignor No. 1—Goods.$ 4,000.00 
“ “ 2 “ 3,500.00 

“ “ 3 “ 1,660.00 

“ “ 3 Ac¬ 
count Current. 650.00 


$ 9,810.00 


Total Credits.$19,346.90 


The nature of the account sales which the factor will 
have to render his principals, will be sufficiently explained 
by the following illustration: 


Account Sales 

New York, June 30, 1914 

Sale of 40 Cases of Merchandise by John 
Harrison, Commission Merchant, for the Ac¬ 
count of H. Marlow, Boston, Mass. 

June 1, 1912 Received, by Steamer Commonwealth, freight 

and charges prepaid: 


123 cases at $20.00. $2,460.00 

30 Inventory: 

83 cases at $20.00. 1,660.00 


Sale of 40 cases—Consigned to me at $20.00_ $800.00 


































CONSIGNMENTS—SHIPMENTS INWARD 


I 99 


Sales and Proceeds: 


June 9 

On Credit, 60 days: 

S. Muller, Hoboken, 

Cases 

Sales 

Price 

Proceeds 

“ 15 

N. J. 

Th. Kemp, Middle- 

10 

$29.00 

1 

$290.00 



town, N. Y. 

7 

30.00 

210.00 

$500.00 


On Credit, Secured by 






Note, 60 days: 





“ 8 

M. Turner, Buffalo, 

N. Y. 

For Cash: 

5 

30.00 


IS 0.00 

“ 22 

S. Archbold, New 



• ' 



York, N. Y. 

18 

28.277 


509.00 


Total . 

40 



$1,159.00 


Held until Collection, as 

per 

agree- 




ment: 

Accounts Receivable.. 



$500.00 



Promissory Note.. 



150.00 

650.OO 


Proceeds Subject to Remittance.... $509.00 

Charges to Your Account: 

Freight, Cartage, etc. (None)_ $.. 

Allowances to Customers “ . 

Commissions of 10% on all sales, 
as per agreement—My Check 


No.drawn against you_ 115.90 115.90 

Net Cash Proceeds, Remitted Here¬ 
with, Check No. $393-10 


John Harrison, 

E. & O. E. Commission Merchant. 

It will be noticed that the foregoing account sales 
gives, practically, a copy of the transactions recorded by 
the factor on his books. This is no more than he owes to 
his principals. 

The account reflects the debits and the credits made 
to the consignment account (Dr. $2,460.00; Cr. $800.00), 
and the balance of the account ($1,660.00). It also re- 






















200 


THE THEORY OF THE ASSET ACCOUNTS 


fleets the credits given and the debits made to the current 
account of the consignee, and the balance of that account 
(Cr._, $1,159.00; Debits: Commissions, $115.90; Cash, 
$393. 10 ; Total, $509.00; Balance, $650.00) and finally, it 
gives the amounts debited to Cash, to Accounts Receiv¬ 
able, and to Promissory Notes Receivable, and the 
amounts credited to Cash. 

Books of the Factor—Agency Accounts Kept in Separate 

Books 

The second method differs from the first, only in that 
it compels the factor to keep, in connection with the 
agency work, a separate set of books comprising: 

1. General ledger 

2. Consignments received book 

3. Consignment sales book 

4. Agency cash book 

5. Agency journal 

6. Consignment customers ledger 

Each book must be so arranged that all the trans¬ 
actions will be classified with due respect to the individual 
consignor whose accounts they affect. The accounts kept 
will be precisely the ones referred to in connection with 
the first method and the results obtained will be similar 
in every respect. Figures 35 and 36 illustrate forms of 
these books. 

These books may be either loose-leaf, or bound. In 
either case as many pages are devoted to each consignment 
as may be needed according to the tenor of the agreement. 

The space allotted to each individual consignor is ear¬ 
marked by a tab bearing the number given to the series of 
accounts which contain all the transactions with him. 

Reference to the consignment agreement, the number of 
which appears in the consignments received book, will give 
all required information when the occasion arises. 


CONSIGNMENTS—SHIPMENTS INWARD 


201 



Figure 35. Consignments Received Book 

















































































202 


THE THEORY OF THE ASSET ACCOUNTS 



Figure 36. Consignments Sales Book 






























































































CONSIGNMENTS—SHIPMENTS INWARD 


203 

The Recording of Consignments Inward—Occasional Con¬ 
signee 

The general books already described will be found 
to work to the satisfaction of the trader or manufacturer, 
who, for valuable consideration, is willing to sell goods for 
the account of others when the occasion arises; and this, 
whether or not he considers himself as a factor or as an 
agent. As to separate books, these are, of course, out of 
the question, so far as the occasional consignee is con¬ 
cerned. 

The Occasional Consignee Theory 

In connection with the recording of the transactions 
incident to the acceptance of occasional consignments in¬ 
ward, there exists a rather peculiar theory which 
apparently has been adopted by more than one of the 
schools where accounting is taught. Ignoring entirely 
the business of the factor, as well as the statutes which 
have been enacted both for his protection and for that of 
his principals, it takes the occasional consignee as a basis, 
and appears to be satisfied to establish a philosophical line 
of distinction between what it calls the two recognized 
methods which the science of accounting has placed at the 
disposal of the consignee for the recording of the trans¬ 
actions incident to his acceptance of goods on consign¬ 
ment, and to the sale thereof. The arguments on which 
this theory rests, are as follows: 

First Argument and Method 

While consigned goods are not an asset of the con¬ 
signee, and do not raise the question of liability until sold, 
they must be reflected in the general books in order that 
all the facts relating to the operations of the period may 
be recorded, whether they be financial, historical, or statis- 


204 THE THE0RY 0F THE ASSET accounts 

tical. To effect this, the requirements of the following 
method must be met: 

1. Upon receipt of consignments: 

a. Debit Consignment account: 

(1) With the disbursements incurred for 

freight, insurance brokerage, etc., 
which are to be eventually charged 
to the consignor. 

(2) With the consigned value of the goods. 

b. Credit consignors with the consigned value 

of the goods. 

2. As sales take place : 

Debit customers and credit consignment ac¬ 
count with the consignment value of the 
goods sold. 

3. Monthly (or oftener if the agreement provided): 

a. Credit consignment and debit consignor with 

the expenses incurred for his account, as 
reflected by the Consignment account. 

b. Debit consignor and credit Commission ac¬ 

count with commissions earned on sales, as 
per agreement. 

c. Debit consignor, and credit Accounts Pay¬ 

able, with the net amount due to con¬ 
signors. If the liability to consignor is 
liquidated at once, debit the consignor, 
and credit Cash, or Notes or Accounts 
Payable, as the case may be. 

d. Credit consignment (old account) and debit 

consignment (new account) with the con¬ 
signed value of the inventory remaining on 
hand. 

At this point, the consignment account and the con¬ 
signor’s account would be equal. On the balance sheet, 


CONSIGNMENTS—SHIPMENTS INWARD 


205 

show the consigned goods as an asset, and the consignor’s 
account as a liability. 

A slightly different handling, under this method, is to 
charge consignors and credit cash with the expenses in¬ 
curred for their account, thus leaving the consignment 
account unaffected by the charges which the consignors 
have agreed to meet. 

Second Argument and Method 

Consigned goods not being assets of the consignee, 
and raising no question of liability until sold, should not 
be placed on the general books. The data concerning 
consignments should be kept in memorandum books from 
which the liability of the consignee to the consignor for 
goods sold, the charges to customers, and the debits and 
credits to other sundry accounts, can be abstracted 
periodically. To this effect, comply with the following 
rules: 

1. When consignments are received: 

a. In the general books: 

Debit consignment with freight and ex¬ 
penses, and credit cash with the expenses 
incurred for the account of the con¬ 
signors. 

b. In a memorandum consignment book: 

Record the receipt of the goods, stating in 
appropriate columns, the date of receipt, 
the name of the consignor, the consigned 
value, and, generally, any information 
which may be found useful either for 
purposes of identification or for purposes 
of bookkeeping. 

2 . When consignments are sold: 

Record, in a memorandum consignments sales 
book, the date of the sale, the amount sold, 



206 THE theory of the asset accounts 


the name of the customer to whom sold, the 
amount of sales returned, the allowances 
made for defective goods, the name of the 
consignor for whom sold, and any other useful 
information. 

3. Monthly, or oftener if required: 

Prepare from the memoranda books, and submit 
to the bookkeeper, the following data which 
will permit him to journalize the facts con¬ 
cerning consignments: 

a. Names of consignors for whose accounts 

sales are made 

b. Names of customers to whom goods were 

sold 

c. Amount of sales, returns, allowances, etc. 

4. From these facts, and the data concerning con¬ 

signment expenses and advances, if any, on the 
general books, the general bookkeeper prepares 
the following journal entries:* 

Customers’ Controlling Ac¬ 
count (say).$20,000 


To Consignment Freight 

Expenses (say).... $ 60.00 

“ Commissions. 2,000.00 

“ Accounts Payable. . . . 17,940.00 


To charge the customers whose names follow, 
with the net sale price of consigned goods, 
and the consignors whose names follow, with 
the expenses incurred for their account and 
the commissions on the sales, and to transfer 
the net liability to consignors to accounts 
payable, as per accounting below: 

* In connection with advances to consignors a second journal entry must be 
made, transferring to the debit of consignors, as appearing in the accounts pay¬ 
able, the amount of the account to which the advances were temporarily debited 
when made. 





CONSIGNMENTS—SHIPMENTS INWARD 


207 


Customers 


Names 

Gross 

Sales 

Returns 

Allow¬ 

ances 

Discounts 

Net Sales 


l 






Creditors 


Names 

Consign¬ 
ment No. 

Gross 

Sales 

Com¬ 

missions 

Freight 

and 

Expense 

Returns, 
Allow¬ 
ances and 
Discount 

Net Lia¬ 
bility 









5. On the balance sheet, show neither the item “Con¬ 
signments” nor the item “Consignors.” 

The soundness of the foregoing theory is challenged, 
because it causes the facts to be recorded illegally, and 
because it ignores the rights, privileges, and duties of the 
consignee. Why should a consignee increase the book 
amount of his creditors’ accounts to the extent of sales 
of consigned goods sold on credit, when it is a fact that 
he is not liable for them until the customers’ accounts are 
collected, unless he has specifically agreed to hold himself 
so liable ? Correspondingly, why should he deliberately 
distort the truth by showing among his assets, “Cus¬ 
tomers’ Accounts Receivable,” which not only do not be¬ 
long to him, but which the law forbids him to mix with 
his own? Lastly, why should he expose himself to ex¬ 
pensive and discreditable litigation by preparing a balance 
sheet showing an item “Cash in Banks” which contains 
moneys to which he has no right whatever? 
































CHAPTER XVIII 


CONSIGNMENTS—SHIPMENTS OUTWARD 
Accounting Methods 

In connection with the recording of the transactions 
incident to the shipment outward of goods consigned, we 
are again confronted with several accounting methods, 
revolving around the following hypotheses: 

1. The goods consigned outward are credited at cost 

to the account with merchandise, and con¬ 
signed at cost. 

2. The goods consigned outward are credited at sale 

price to the account with merchandise, and con¬ 
signed at sale price. 

3. The goods consigned outward are not credited to 

the account with merchandise, and are consigned 
either at cost or at sale price. 

The object of the first method is to differentiate the 
gross profits made by the concern on the goods sold by its 
own organization, from the profits made on goods intro¬ 
duced in domestic or foreign markets through the medium 
of consignees. 

The object of the second method is to treat goods 
consigned outward, precisely as if they were sold by the 
concern itself, or held by it at inventory times. 

The object of the third method may be the same as 
that of either of the other two, the distinction being that 
instead of recording the transactions in the real accounts 
as they stand on the books, there is created during the 

208 


CONSIGNMENTS—SHIPMENTS OUTWARD 


209 

accounting period a series of statistical accounts which 
appear either in the general books or in memoranda books, 
and permit of periodically ascertaining the effect of con¬ 
signments upon the real accounts, as well as upon the 
income of the concern. 

First Hypothesis 

Considering the first hypothesis and assuming that 
there were consigned goods worth $1,000, the journal 
entry giving expression to the facts would be: 

Consigned Shipment No. 1.$1,000.00 

To Merchandise. $1,000.00 

For cost of goods consigned 
to John Doe, for sale by 
him subject to the follow¬ 
ing conditions: (Recite con¬ 
ditions.) 

Supposing, now, that part of the goods consigned 
outward had been sold by the consignee for $1,000, sub¬ 
ject to commissions of $100, freight and expenses amount¬ 
ing to $35, and refunds to customers for defective goods, 
amounting to $15, as per account sales rendered by 
consignee to consignor, showing a remittance of $850 and 
a remaining inventory of $500 figured at cost. The ex¬ 
pression of the above facts in general journal form might 
be as follows: 


1. Cash. $850.00 

Commissions on Consigned Shipment No. 1. 100.00 

Allowances on Consigned Shipment No. 1. 1500 

Freight and expenses on Consigned Shipment 

No. 1. v .. 35-00 

To Consigned Shipment No. 1. $1,000.00 

To record the transactions of the period in 
connection with goods consigned outward, 
as shown by the account sales rendered by 
John Harrison. 









210 


THE THEORY OF THE ASSET ACCOUNTS 


2. Consigned Shipment No. i (new account). $500.00 

To Consigned Shipment No. 1 (old ac¬ 
count) .. $500.00 


To set up the inventory as shown by schedule 
attached to account sales rendered this day 
by consignee. 


3. Consigned Shipment No. 1...... $500.00 

To Profit and Loss. $500.00 

For gross profit on sales of goods consigned 
outward. 

4. Profit and Loss. $150.00 

To Commissions on Consigned Shipment 

No. 1. $100.00 

“ Allowances on Consigned Shipment 

No. 1. 15.00 

“ Freight and Expenses on Consigned 

Shipment No. 1. 35-00 

To close into the Profit and Loss account the 
expenses incident to consigned shipments, 
and the allowances on defective goods. 


After the foregoing entries have been posted, the 
status of the account “Consigned Shipment No. 1” is as 
follows: 


Consigned Shipment No. i 


Merchandise (cost).$1,000.00 

Profit and Loss... 500.00 


$1,500.00 


Inventory (cost). 500.00 


Sundry.$1,000.00 

Inventory (cost). 500.00 


$1,500.00 


Thus, we see that the purpose of this method is ful¬ 
filled through the raising of an account which will separate 
the goods consigned from the merchandise to be sold by 
the concern itself, and subsequently record only such 
transactions as contribute to the gross profit on sales, 
either in a positive or in a negative manner. As to the 
expenses and losses incurred as a result of the consign- 




















CONSIGNMENTS—SHIPMENTS OUTWARD 2II 

ment, they were recorded in properly earmarked nominal 
accounts which will eventually be closed into Profit and 
Loss, where they will be opposed to the gross profit on 
consignments, in order that the selling profit thereon may 
be ascertained. 


Second Hypothesis 

Under the second hypothesis the goods consigned out¬ 
ward are credited at sale price to the account with 
merchandise and consigned at sale price. Let us consider 
the case of goods costing $1,000, consigned outward at 
their sale price of $1,500, subject to a commission of 10% 
on the sale price. In due course, the consignee renders 
an account sales showing that he has sold goods to the 
amount of $1,000, and submits an inventory showing that 
he still has on hand goods worth, at sale price, $500. He 
claims allowances of $15 refunded to customers on ac¬ 
count of defective goods, and freight and expenses of $35, 
both of which the consignor must stand; he also takes 
credit for his commission and for his cash remittance. 

The entries necessary to record these transactions on 
the books of the consignor might be expressed in general 
journal form: 


I. Consigned Shipment No. 1.. $1,500.00 

To Merchandise.. $1,500.00 

For $1,000 worth of goods consigned at sale 
price to John Harrison, consignee. 


2. Cash (Consignee No. 1).«. $850.00 

Commissions on Consigned Shipment No. 1.... 100.00 

Allowances on Consigned Shipment No. 1. 15 -°° 

Freight and expenses on Consigned Shipment 

No. .... 35-00 

To Consigned Shipment No. 1.« $1,000.00 

To record the transactions of the period in 
connection with goods consigned outward, 
as shown by account sales rendered by 
John Harrison. 








212 


THE THEORY OF THE ASSET ACCOUNTS 


3. Consigned Shipment No. 1 (new account). $500.00 

To Consigned Shipment No. 1 (old ac¬ 
count) . $500.00 

To set up inventory, as shown by schedule 
attached to account sales rendered this 
day by consignee, John Harrison. 

4. Profit and Loss. $ 150.00 

To Commissions on Consigned Shipment 

No. 1. $100.00 

“ Allowances on Consigned Shipment 

No. 1. 1500 

“ Freight and Expenses on Consigned 

Shipment No. 1. 35-00 

To close. 


At this point, the status of Consigned Shipment Ac¬ 
count No. 1 would be: 


Consigned Shipment No. 1 


Merchandise (sale price) .$1,500.00 

Sundry .. 

Inventory . 


$1,500.00 


$1,500.00 

Inventory... 500.00 




while the status of the account with merchandise would be: 


Purchases (say) 


Merchandise 


$20,000.00 


Sales—Concern (say).. .$10,000.00 
Sales—Consignee (Ship¬ 
ment No. 1.).. 1,500.00 


If, in the above example, all the goods consigned had 
been sold at the end of the accounting period, it would 
appear that the method of handling consignments had 

adequately fulfilled its purpose. But since all the goods 

* 

have not been sold, and since, further, the consignor 



















CONSIGNMENTS—SHIPMENTS OUTWARD 


213 


wishes to close his books and ascertain his profit, it is 
necessary to temporarily relieve the merchandise account 
of the gross profit on goods consigned outward, which 
was included in the account at the time of the consign¬ 
ment. This is done by means of the following journal 
entry: 

Merchandise .$500.00 

To Consigned Shipment No. 1 $500.00 

To send back to the former ac¬ 
count, at the value at which it 
was formerly credited thereto, 
the remaining inventory of 
goods shipped outward on con¬ 
signments. 

As soon as the profit of the period is ascertained, the 
above entry is reversed. 


Third Hypothesis 

Under the third hypothesis, goods consigned outward 
are not credited to the account with merchandise, and 
are consigned either at cost or at sale price. Two methods 
of recording are available. 


First Method 

1. If goods are consigned at cost price, record the 
material facts relating to the consignments outward, as 
follows: 


a. When shipping goods on consignment: 


Debit Consignee 
No. — 

Credit Consigned 
Shipment No. — 


with cost of the goods 
shipped. 





THE THEORY OF THE ASSET ACCOUNTS 


214 


b. When consignee renders account sales: 
(1) Debit Profit and 
Loss 

Credit Consignee 
No. — 


with the commissions, ex¬ 
penses, and allowances. 


(2) Debit Consignee 

No. — 

Credit Profit and 
Loss 

(3) Debit Cash 
Credit Consignee 

No. — 

(4) Debit Consigned 

Shipment 
No. — 

Credit Merchan¬ 
dise 


with gross profit on sales as 
reported and collected. 


with remittances on ac¬ 
count of collected sales. 


with the cost price of goods 
sold on consignment. 


2. If goods are consigned at sales price, record the 
facts relating to consignments outward as follows: , 

a. When shipping goods on consignment: 


Debit Consignee 
No. — 

Credit Consigned 
Shipment No. — 


with the sales price of goods 
consigned. 


b. After consignee has rendered account sales: 


(1) Debit Profit and 
Loss 

Credit Consignee 
No. — 


with commissions, expenses, 
and allowances. 









CONSIGNMENTS—SHIPMENTS OUTWARD 


2I 5 


( 2 ) 


Debit Consigned 
Shipment 


No.— 


with proceeds of goods 
sold. 


Credit: 

(a) Merchan¬ 
dise 


with the cost of the con- 

► 

signed goods sold for cash. 



The Profit 
and Loss 
Account 


with the gross profit on the 
sales of consigned goods. 



Debit Cash 
Credit Consignee 
No. — 


*with remittance. 


To illustrate this first method available under the 
third hypothesis, let us assume that goods costing $2,000 
have been consigned to John Harrison, (1) at cost, (2) at 
sale price, and that, in either case, the consignee has sold 
a certain amount of goods the cost of which was $1,000 
to the consignor. The consignee renders an account sales, 
deducting from his remittance 10% for commissions on 
gross sales, $35 for allowances to customers, and $75 for 
expenses paid by him for the account of the principal. 

The ledger accounts of the consignor, as affected by 
both assumptions will be: 

Example No. 1 

(Ledger accounts of the consignor, as affected by the recording of the 
transactions incident to the consignment of goods at cost, and to the 
partial sale thereof by the consignee.) 

Consignee No. 1—J. Harrison 

Consigned Shipment No. Profit and Loss—Com- 

1 .$2,000.00 missions .$ 150.00 











216 THE theory of the asset accounts 


Consignee No. i —J. Harrison —Continued 


Profit and Loss—Excess 
of sale price over cost, 
on sale of consigned 
goods, i. e., gross profit 
on sales . 500.00 

Profit and Loss—Allow¬ 
ances . 35-00 

Profit and Loss — Ex¬ 
penses . 75-00 

Cash—Remittance. 1,240.00 

Balance. 1,000.00 

$2,500.00 

$2,500.00 

Balance .$1,000.00 



Consigned Shipment No. i 

Merchandise (Cost of Consignee No. i 

Consignments sold)... .$1,000.00 
Balance. 1,000.00 

$2,000.00 

Balance. 

Cash 

Consignee No. 1.$1,240.00 


$2,000.00 


$2,000.00 

$1,000.00 


Profit and Loss 


Consignee No. 1— 

Commission, Consign- 

ment No. 1.$150.00 

Allowances on Consign¬ 
ment No. 1. 35.00 

Expenses on Consign¬ 
ment No. 1. 75.00 


Consignee No. 1—Gross 
Profit on Consigned Ship¬ 
ment No. 1.$500.00 


Merchandise 


Purchases—say: .$10,000.00 


Sales by the concern itself, 

say: .$6,000.00 

Consigned Shipment No. 

1—Cost of goods con¬ 
signed and sold, gross 
profit on which is re¬ 
corded in the Profit and 
Loss account. 1,000.00 







































CONSIGNMENTS—SHIPMENTS OUTWARD 217 
Example No. 2 

(Ledger accounts of the consignor, as affected by the recording of the 
transactions incident to the consignment of goods at sale price, and to 
the partial sale thereof by the consignee.) 


Consignee No. i—John Harrison 


Consigned Shipment No. 

1.$3,000.00 

Profit and Loss—Com¬ 
missions .$ 150.00 

Profit and Loss—Allow¬ 
ances . 35-00 

Profit and Loss — Ex¬ 
penses . 75-00 

Cash—Remittance. 1,240.00 

Balance . 1,500.00 

$3,000.00 

$3,000.00 

Balance.$1,500.00 



Consigned Shipment No. i 


Merchandise. 

Profit and Loss- 

Profit . 

Balance. 

-Gross 

Consignee No. 1.$3,000.00 


$3,000.00 

$3,000.00 



Balance.$1,500.00 


Cash 

Consignee No. 1- 




Profit and Loss 

Consignee No. 1— 
Commissions .... 

Allowances. 

Expenses . 

. 3500 

. 75 00 

Consigned Shipment No. 1.$500.00 


Merchandise 

Purchases—say: ... 

_$10,000.00 

Sales by the concern, 


say: .$6,000.00 

Consigned Shipment No. 

1 


I/XX). 00 









































2 i8 the theory of the asset accounts 



Figure j/. Consigned Shipments Memorandum Book 






























































































































CONSIGNMENTS—SHIPMENTS OUTWARD 


219 


After the accounts are closed as shown in the fore¬ 
going examples, the account of the consignee and the 
account with consigned shipment are purely statistical, 
and have no place on the balance sheet. 


Second Method 


1. If goods are consigned at cost: 

a. When shipping: 

Record the facts relating to consignments in a 
memorandum book, as per example on page 
218, and make no entry whatever in the general 
books. 

b. After receipt of account sales: 

Record the facts contained therein, in the 
memorandum consigned shipments book, as 
per example in Figure 37. 

c. At any time during the accounting period, using 

the data furnished by the memorandum book, 
make in the journal and in the cash book the 
entries expressed here in general journal form: 

Cash .$850.00 

Commissions—Consigned Shipment 

No. 1. 100.00 


Freight and Expense on Consigned 

Shipment No. 1. 35 -°° 

Allowances to Customers on Con¬ 
signed Shipment No. 1. 1500 

To Merchandise. $500.00 

“ Profit and Loss. $500.00 


To record the transactions of 
the period concerning con¬ 
signment No. 1, in so far as 
they have affected the assets 








220 THE THEORY OF THE ASSET ACCOUNTS 

and the income, as per ac¬ 
count sales No.-received 

this day from Consignee No. 
i, and as reflected by the 
memorandum consigned ship¬ 
ments book. The amount 
credited to merchandise is 
the cost of the goods sold. 

2 . If the goods are consigned at sales price, plan the 
memorandum consigned shipments book in such a manner 
that the cost of the goods will be opposed to the sale 
price, as well when they are consigned as when they are 
sold. The journal entry to be made at the time the 
account sales is rendered, is identical in every respect 
with the above. 

Before leaving the subject of consignments, it may 
be well to state that since the consignee is not liable for 
uncollected sales unless he has agreed to hold himself so 
liable, the consignor should not consider as sales what 
has been sold on credit. Unless this be done, there will 
exist no harmony whatever between the books of the 
principal and of the agent; the books of the consignor 
will show that he has a claim against the consignee, 
whereas the latter’s books will fail to reflect a liability 
therefor. 



CHAPTER XIX 


LAND AND BUILDINGS 

Distinction Between “Land” and “Buildings” 

To the average layman, there is no difference between 
the two elements of the account “Land and Buildings.” 
Giving as his authority the common law, which made the 
term “real” apply to land, tenements, and hereditaments, 
he is satisfied to call both real estate. The courts do not 
usually attempt to differentiate the two terms, except in 
special cases, as that of Truesdell v. Gay,* where the 
court, referring to the word “building,” seemed to be of 
the opinion that, taken in its broadest sense, it could not 
be made to apply to such erections on land as fences, 
gates, and other such structures. The accountant, how¬ 
ever, must often draw a very sharp line not only between 
the two values, land and buildings, but as well, between 
that part of the land which is necessary to the proper 
working of the plant, and that part which could be sold 
without in any way interfering with its operations. 

The components of the cost of plant land vary 
materially from those of investment land; the considera¬ 
tion of increases in market values, while of much im¬ 
portance in the case of the latter, is merely an incident in 
the case of the former, since the asset cannot ordinarily 
be sold without causing operations to come to an end, at 
least temporarily. On the other hand, buildings de¬ 
preciate through wear and tear, while land does not; 


*13 Gray (Mass.), 311, 312. 


221 



222 THE THEORY of the asset accounts 

hence, if reserves are created for the depreciation of build¬ 
ings, and applied for balance sheet purposes to Land and 
Buildings account, it is not possible to ascertain the book 
value of the asset which the depreciation affects. 

These accounting differences in the nature of the two 
values, land and buildings, would seem to be sufficient to 
cause the creation of two distinct accounts with them, and 
are generally so regarded. 

Plant Land 

That part of the land which the buildings occupy, or 
which is necessary to the proper working of the plant, 
should be kept by itself in the account “Plant Land.” 

As part of the plant, land may be charged at the time 
of acquisition, not only with the cost of purchase, but 
with all the expenses incident thereto, such as title search¬ 
ing and insuring, commissions to real estate agents, 
recording of deeds, etc. After it has been acquired, and 
until operations have begun, it can be charged with in¬ 
terest on the purchase-money mortgage (or on any other 
obligation incurred in its acquisition) and with the cost 
of fencing, erecting gates and approaches, filling in, 
draining, leveling, etc., incident to the erection of the 
plant. As soon, however, as the plant has begun opera¬ 
tions, the value of plant land can only be increased by 
the cost of such improvements as enhance the efficiency of 
the buildings erected thereon, or increase their useful life 
by remedying conditions which tend to make structures 
deteriorate faster than might reasonably be expected. 

The question of cost of improvements which tend to 
make plant land more valuable for any purpose other 
than the one for which it was acquired, while admittedly 
important in determining its cost if a sale is contemplated, 
should not be permitted to influence the appraisal of 
values for the purposes of a going concern. 


LAND AND BUILDINGS 


223 


Investment in Lands 

Any parcel of land owned and not at present neces¬ 
sary to, and not likely to be required for, the operations 
of the plant, is essentially an investment. The true rea¬ 
son for acquiring it may not have been a desire for profits. 
It may be that in order to obtain a desirable plot it was 
necessary to purchase adjoining land which had no special 
value for the purpose of the plant; or it may be that the 
purchase was made with a view of preventing the erec¬ 
tion in the immediate neighborhood of competing or 
light-obstructing plants; whatever the reason, a certain 
amount of capital has been used for the acquisition of a 
value not required for operating, and the cost of carrying 
it may properly include betterments, maintenance of 
fencing, taxes, interest on the purchase-money mortgage, 

etc., even after operations have begun. 

% 

Buildings 

The Buildings account is capable of apparently har¬ 
monious action, even though elements which are really 
foreign to it are introduced in its make-up. Therein lie 
both its importance and its danger. 

If we were to attempt to inject into the account with 
customers, transactions which have no relation whatever 
with sales and settlements thereof, we would obtain re¬ 
sults which, by comparison with others, would carry on 
their face the evidence n{ inaccuracy. If, on the other 
hand, we were to include on either side of the account 
with merchandise, elements of cost and elements of deduc¬ 
tion from cost which have no relation whatever with mer¬ 
chandise, we would distort the truth about certain phases 
of the profits, but we would not change the net result of 
the operations of the period. 

In the case of buildings, however, the situation is 
quite different. The account offers the opportunity of 


224 THE THEORY of the asset accounts 

capitalizing expenditures in order that the profits of the 
period may be inflated, or of reducing the income by 
charging to revenue the cost of adding to, or enlarging, 
the structures, as well as the cost of extending their useful 
life, which should have been capitalized. That concerns 
have frequently taken advantage of that opportunity is 
not to be doubted; that it can be done successfully and, it 
may be said, without much danger, is due to the fact that 
the standards by which the components of the Buildings 
account (in common with all other so-called property ac¬ 
counts) are judged, may be stretched to accommodate any 
personal opinion not too grossly unreasonable. 

The original cost of the buildings is seldom a question 
at issue so far as the accountant is concerned. If the 
buildings have been acquired from another concern, he 
is not competent to pass judgment upon the price paid 
for them; nor is he asked to do so. All he has to do is to 
record the transaction. If the buildings have been erected 
under a contract, the situation is precisely the same; if 
they have been constructed by the concern itself under a 
special contract calling for the payment to the builder of 
a certain percentage of the cost, the true cost of the build¬ 
ings will, of course, be whatever has been expended under 
the direction of the builder, plus the fees paid to him as 
per contract. In this latter case the interest on the money 
which the concern may have had to borrow pending con¬ 
struction, in order to meet the bills of the builder, will also 
be considered as a proper cost of the structures. Lastly, 
if the construction is attended to by the concern itself, 
upon plans submitted by an architect, the cost of the 
building will include his fees, the expenses incurred in 
connection with permits, licenses, etc., the cost of in¬ 
surance protection, the cost of all material used, the cost 
of the labor expended on the foundations as well as on 
the structures, the cost of any outside labor which may 


LAND AND BUILDINGS 


225 


have been required, the proportion of the overhead ex¬ 
penses which apply to the construction, the interest on 
any moneys which have been borrowed for construction 
purposes and used therefor, up to the time when the new 
buildings were opened for operation. 

In regard to what constitutes the cost of material, sup¬ 
plies, and labor consumed in construction, the rulings of 
the Public Service Commission are of interest to all con¬ 
cerns, whether or not they fall under the class of business 
organizations which the commission controls, for they 
embody the views which accountants generally hold on 
the subject. 

“Cost of labor (employed in construction) includes not 
only wages, salaries, and fees paid employees, but also 
such personal expenses of employees as are borne by the 
corporation. Cost of materials and supplies consumed in 
construction, is the cost at the places where they enter 
into construction, including cost of transportation and 
inspection when specifically assignable. If such materials 
and supplies are passed through storehouses, their cost as 
entered in the account may include a certain proportion 
of store expenses.” 

It is an open question as to whether or not it is proper 
to add to the overhead expenses applicable to construc¬ 
tion, an extra amount representing the profit which a con¬ 
tractor would have added to the price quoted for the 
buildings. It is claimed by some that the cost of the 
buildings constructed by a concern for itself, presumably 
because it can erect them at better terms than would be 
possible if the work were given to contractors, should be 
such as to reflect the saving realized by the company. It 
is claimed by others that the cost to the company may 
be stated at a figure representing precisely what it would 
have had to pay if outsiders had attended to the con¬ 
struction. This latter theory may appeal to the statis- 


226 THE theory of the asset accounts 


tician and to the independent appraiser, but its effect 
upon the results of the operations is so marked as to be 
obnoxious to the accountant. Assuming, for instance, 
that a company were to build an additional plant during a 
certain operating period, and add to the cost of the build¬ 
ing an amount of overhead expenses calculated to cover 
not only the proper proportion which the work performed 
would naturally warrant, but, as well, the profits which a 
contractor would have realized on the work, it stands to 
reason that the results of the operations of that period 
may show improvements over past periods which disturb 
comparisons and lead to erroneous judgment of condi¬ 
tions in regard to carrying capacity. 

After the original cost of buildings has been recorded, 
all subsequent charges to the account raise the ever¬ 
present and delicate question of the proper separation of 
capital expenditures and revenue expenditures. 

Capital Expenditures 

When subjected to a theoretic analysis, this term ap¬ 
pears to apply to such expenses as, in the aggregate, rep- 

* 

resent the cost of the increased earning capacity of the 
enterprise as a whole or of particular parts thereof, which 
has been secured over the earning capacity known to 
exist before the said expenses were incurred. 

Revenue Expenditures 

In contradistinction, these expenses are such as must 
be incurred in order that advantage may be taken of the 
earning capacity of the enterprise, or in order that such 
capacity may be maintained at the required standard. 

If the radius of action of a locomotive is 200 miles on 
a certain amount of fuel, water, and lubricants, and, if 
through the addition of, say, a steam condenser to the 
mechanical equipment of the engine, that radius is ex- 



LAND AND BUILDINGS 


227 


tended to 250 miles on the same consumption of fuel, 
water, and lubricants, it is obvious that the value of a 
capital asset has been enhanced as an income producer, 
and that the cost of the increased earning power may be 
capitalized. But if, on the other hand, the additional 
equipment of the machine has only resulted in maintain¬ 
ing an efficiency which would otherwise have been im¬ 
paired, there has been incurred an expense necessary to 
obtain revenue, that is to say, a revenue expenditure. 

Writing on the subject of “The Accounting of Indus¬ 
trial Enterprises,”* William M. Lybrand, C.P.A., says: 
“With respect to items which may properly be considered 
as capital expenditures, it has been suggested as a work¬ 
ing basis that no addition should be made to the property 
accounts unless it can be clearly shown that they have 
increased the earning capacity of the plant. A simple, 
positive rule such as this might be all that is required, if 
the changes in the plant and the resulting increase in 
earning capacity were occasioned only by actual exten¬ 
sions or additions of property which had never before ex¬ 
isted. But such is not the case. In every progressive 
manufacturing concern, alterations or additions to the 
plant are constantly being made for the purpose of sim¬ 
plifying the manufacturing processes and thereby increas¬ 
ing the output with the same expenditure for labor and 
materials, or in order to decrease those operating charges 
which are in the nature of overhead expenses required to 
be taken up in the cost of the product. As no alteration 
or addition to the plant is probably ever undertaken ex¬ 
cept for the purpose of increasing the earning capacity 
thereof, directly or indirectly, the literal application of the 
rule referred to is not possible, and it will be necessary to 
consider the nature of the various alterations, improve¬ 
ments, and additions, before an intelligent decision can be 
made as to their ultimate disposition.” 


* Journal of Accountancy. December, 1908. 



228 THE THEORY of the asset accounts 


In the Journal of Accountancy of November, 1906, 
John P. Herr says on the same subject: 

“One of the most difficult things with which the ac¬ 
countant has to deal is the question of capital expendi¬ 
tures * * * As capital expenditures are generally 

handled at the present time, a manager who has interest 
in the profits * * * may cover up shrinkages in the net 
earnings, losses by bad management, and defalcations, and 
make it practically impossible for the accountant * * * 
to determine whether the charges are for bona fide bet- • 
terments or not * * * We find in one work on account¬ 
ing a statement that when in doubt as to whether an 
expenditure is a capital expenditure or chargeable against 
revenue, the amount should be charged against capital, 
the reason given being that if it is ‘afterwards’ determined 
that the expenditures were for repairs, it is easy to get 
them out of capital into revenue, while it is extremely 
difficult without much explanation and on proper author¬ 
ity to take items out of revenue and place them into 
capital. The adoption of such a policy by accountants 
will add to the already great laxity in this direction, and 
tend towards the lowering of professional standards.” 

As bearing upon the subject of capital expenditures, 
the following quotations from a pamphlet issued by the 
Public Service Commission, First District, State of New 
York, may be of interest: 

Additions. “Additions include additional structures, 
facilities, or equipment not taking the place of anything 
previously existing.” 

Betterments. “Betterments include the enlargement 
or improvement of existing structures, facilities, and 
equipment.” 

Renewals. “Renewals include all extensions of terms 
of years in land and tangible fixed capital, and all exten- 


LAND AND BUILDINGS 


229 


sions of the life period of franchises and other intangible 
fixed capital.” 

Replacements. “Replacements include all substitu¬ 
tions for capital exhausted or become inadequate in 
service, the substitutes having substantially no greater 
capacity than the things for which they were substituted. 
When a substitute has a substantially greater capacity 
than that for which it is substituted, the cost of substitu¬ 
tion of one of the same capacity as the thing replaced 
should be charged as a replacement, and the remaining 
portion of the cost of the actual substitute should be 
charged as a betterment.” 

Repairs. “When through wear and tear or through 
casualty it becomes necessary to replace some part of any 
structure, facility, or unit of equipment, and the extent of 
such replacement does not amount to a substantial change 
of identity in such structure, facility, or unit of equipment, 
the replacement of such part is to be considered a repair, 
and the cost of such repair is to be treated as an operating 
expense, and must not be charged as a replacement in any 
capital account.” 

In connection with land and buildings there often 
arises the question of increased valuation due to favorable 
conditions in the real estate market. Concerns desiring 
to make a good showing for a given period, are not un¬ 
likely to take advantage of upward fluctuations of land, 
in order to inflate their “profits.” The accountant is very 
likely to have in connection with this kind of profits the 
same opinion as the average lawyer has about all kinds of 
gains. To the lawyer, nothing is profit which has not 
been realized in cash. To the accountant, nothing brings 
profits which has not been sold. He instinctively objects 
to all kinds of estimates and inflations of capital assets on 
the basis of market values. He is inclined to think that 
since business requires its capital assets in order to oper- 


230 THE THEORY OF THE ASSET ACCOUNTS 

ate, it cannot afford to sell them; hence, the taking of 
profits on values supposed to be invested permanently, 
might well be deferred until they are sold, either because 
operations have come to an end or because more favorable 
conditions elsewhere have made advisable the removal of the 
plant. 


CHAPTER XX 


BUILDING EQUIPMENT, FURNITURE AND 
FIXTURES, DELIVERY EQUIPMENT, 
PATTERNS, OTHER EQUIPMENT 

Realty Fixtures and Personalty Fixtures 

The question of the proper differentiation of realty fix¬ 
tures and personalty fixtures is of interest to accountants, 
since it involves the possibility of lawsuits in connection with 
the foreclosure of mortgages on buildings and on their 
equipment, the rights of the parties to a contract of sale of 
realty, the rights of the landlord and of the tenant, and the 
important matter of accurate accounting in connection with 
bankruptcy proceedings and receiverships. 

Realty fixtures are part of the building to which they 
are annexed, and their value should either be added to the 
value of the building, or stated in a separate account with 
building equipment, or in a group of accounts representing 
that equipment. Personalty fixtures are neither part of the 
building nor of its equipment; they are not considered as 
part of the property pledged under a mortgage, and they can 
be sold, removed, changed, destroyed, or otherwise disposed 
of, without in any way affecting the value of the building or 
the rights of any one who has, or may have, an interest in 
the structure. 

Realty fixtures may, under certain conditions, include 
elements which accountants are sometimes satisfied to call 
“machinery” or “machinery and tools.” When such is the 
case, what is the worth of the information supplied by books 

231 


232 THE theory of the asset accounts 

of account which state the value of the asset “buildings,” 
in the narrow sense which the word may have, and oppose it 
to a liability account reflecting the mortgage which has been 
placed not only on the structure, but, as well, on all that it 
contains which falls under the meaning of the term “realty 
fixtures” as the law understands it? 

Going a little further, what is the value of a statement of 
affairs which deducts from the amount expected to be 
realized on buildings, the amount of the mortgage placed 
thereon, if part of the value of the said building is to be 
found in the account “Machinery and Tools” ? 

The Law of Fixtures 

The Cyclopaedia of Law and Procedure states that 
“the law of fixtures deals with property whose status as 
realty or personalty is indeterminate until the proof of cer¬ 
tain facts and the application of certain rules of law. When 
the status is thus determined, tangible property must be 
either real or personal. Fixtures then may be defined as 
tangible property whose status as realty or personalty is 
indeterminate. According as certain facts shall appear, its 
status will become determinate, and it will fall into one or the 
other category * * * In the matter of “fixtures” so 

called, it is difficult to say with precision what degree of 
annexation is sufficient to work the change from personalty 
to realty. In some cases the courts have said as a matter 
of law, that certain articles, although fastened to the realty, 
are no part of it, while on the other hand articles may be so 
incorporated with realty that the court will say as a matter 
of law that they are fixtures; but as physical annexation of 
a chattel alone is not always necessary to its becoming part 
of the realty, and as physical annexation alone does not 
necessarily make a chattel realty, but in either case other 
circumstances may combine to prevent the one or the other, 
it is believed that the true rule is that articles not otherwise 


BUILDING AND OTHER EQUIPMENT 


233 


attached to realty than by their own weight are prima facie 
personalty, and articles affixed to land in fact, although only 
slightly, are prima facie realty, and that the burden of proof 
is on the one contending that the former is realty and that 
the latter is personalty.” 

It has been held by courts of law that a heavy statue, 
designed for permanent ornamentation of a building, is part 
of the building, and subject to a mortgage of that building; 1 
that a machine which is attached to its base merely to give it 
stability, is not part of the building; 2 that shelving attached 
to the walls merely to give it steadiness is part of the build¬ 
ing; 3 that a machine attached to the floor to give it steadi¬ 
ness, when it is attached otherwise than by cleats, is part 
of the building; 4 that platform-scales erected in the street, 
but with beams extending into an adjoining building, are 
part of the building; 5 on the other hand, belting, gas fix¬ 
tures, and radiators have, in some cases, been held to be 
realty, while in other cases they have been held to be 
personalty. 

Distinction Between Realty and Personalty Fixtures 

In view of the many differences of opinion which the 
decisions of the courts suggest in the matter of fixtures, it 
seems that the rule contained in the foregoing quotation 
from the Cyclopaedia of Law and Procedure may safely be 
accepted by accountants. Thus, everything permanently 
attached to the building and impossible of removal without 
cutting into walls, ceilings, and floors, or without impairing 
the fitness of the building for the purpose to which it was 
destined, may be properly included in the cost of the build¬ 
ing, or kept in a separate account with building equipment or 
with realty fixtures. Everything which is attached to the 

1 Snedeker v. Warring 1 , 12 N. Y. 170. 

2 McRea v. Troy Cent. Nat. Bank, 66 N. Y. 489. 

3 Stack v. T. Eaton Co., 4 Ont. Rep. 335. 

♦Sun L. Ass. Co. v. Taylor. 9 Manitoba 89. . 

‘Bliss v. Whitney, 9 Allen (Man.) 114; 85 Am. Decennial 745. 



234 THE THE0RY 0F THE ASSET accounts 

building by its weight only, and can be easily removed with¬ 
out in any way interfering with the efficiency of the build¬ 
ing, or defacing it, may be called furniture and fixtures. 

In the former category we would then include: boilers 
and furnaces imbedded in the floors or walls, machines 
sunken in the floor or attached to it in such a manner as to 
be part of it, elevators and the machinery on which they 
depend for power, ventilating systems, water connections, 
piping, feeding wires, inside sewerage and drainage sys¬ 
tems, crane runners and supports, shafting and pulleys which 
are so encased in the walls and ceilings as to necessitate cut¬ 
ting in order to remove them, safes, closets, benches, and 
shelving built in the walls or permanently attached to them, 
etc. 

In the second category (furniture and fixtures) we 
would include chairs, tables, desks, pictures, and other re¬ 
movable decorative objects, files and cabinets, writing, copy¬ 
ing and computing machines, safes not attached to the walls, 
lamps and chandeliers, movable stoves and radiators, and 
generally all the appliances, implements, etc., acquired to 
facilitate the transaction of business, or add to the comfort 
of the officials, employees, and patrons of the concern. 

It is to be understood, of course, that the segregation of 
the building into its components, such, for instance, as 
general building equipment, power plant equipment, boiler 
plant equipment, heating plant, etc., is not condemned, pro¬ 
vided the sundry units are understood to be part of the 
whole, detached for purposes of recording analytically the 
original cost of the‘Units and the subsequent transactions 
affecting them. 

Furniture and Fixtures 

The Furniture and Fixtures account has no well-defined 
theory: what it will contain depends upon the policy of the 
concern as to what it will capitalize and what it will charge 


BUILDING AND OTHER EQUIPMENT 


235 


to operations. Some firms carry their furniture and fixtures 
at their original cost, and charge all subsequent additions, re¬ 
newals, and repairs to the income of the period in which the 
transactions occurred; others add to the original amount the 
cost of what they buy, and credit the account, periodically, 
with an amount representing the difference between the book 
value and the total inventory computed conservatively; 
others still, add the cost of additions to the original value, 
and set aside yearly out of profits an amount which is 
credited to a reserve account and is supposed to reflect the 
amount of depreciation suffered by the property during the 
period. 

Delivery Equipment 

The somewhat antiquated title of Horse, Wagon, and 
Harness, which was formerly applied to this account, is fre¬ 
quently replaced, in these modern days of motor trucks and 
light-power delivery wagons, by the name “Delivery Equip¬ 
ment.” What the account will contain depends upon the 
policy of the concern. It is supposed to include the cost of 
such equipment as is necessary to cart the goods in and out 
of the plant. Like the asset “furniture and fixtures,” it 
may be carried at its original cost, all replacements and 
additions being charged to expense; or the original value 
may be added to whenever transactions take place, the true 
value being obtained through periodical inventories figured 
conservatively. Or again, it may be carried at cost, a cer¬ 
tain amount being periodically set aside out of net profits 
to provide for such depreciation as it is estimated that the 
property may have suffered. 

If losses occur either through natural causes or through 
accidents, the account is credited with the original, or with 
the depreciated, cost of the unit lost (as the case may be) 
and is then debited with the cost of the unit which 
replaces it. 


236 THE THEORY of the asset accounts 

Patterns 

A pattern is “a piece of paper, card-board, sheet metal, 
or thin plank corresponding in outline to an object that is to 
be cut out or fabricated, and serving as a guide in determin¬ 
ing its exact shape and dimensions. Pattern pieces or 
gauges are largely used in making special machinery, in 
which all the parts are made separately by gauges, and then 
put together.”* 

The value at which patterns should be carried on the 
books is, of course, their cost; that is to say, the amount 
of all the expenses which their fabrication has necessitated. 
But, as the value of the pattern is problematic after -the 
object for which it was made is accomplished, the ques¬ 
tion of the ultimate disposition of the asset is important. 

The patterns made for a special machine, which will 
not be used elsewhere than in the plant of the concern 
which built it, have no value unless there is a probability 
that the apparatus will be duplicated at some future time. 
Hence, if the machine is to be the only one of its type, the 
cost of the patterns is an integral part of the cost of the 
machine. In the contrary case it may be retained as an 
asset, at cost. If, peradventure, the object for which a 
pattern is made becomes useless through obsolescence of 
the type, the pattern itself necessarily loses its value. 

Patterns made to standardize the object manufac¬ 
tured, and used constantly as models, may be retained as 
an asset at whatever cost they represent. If their useful¬ 
ness has expired, they should be written off gradually by 
periodical charges to the Profit and Loss account; or a 
reserve may be created for them pending final decision as 
to their ultimate disposition. Under no conditions, how¬ 
ever, should they be charged to cost of manufacture unless 
they were made for a special job and there is no possibility 
of their being used again. 


* Encyclopaedic Dictionary. 



BUILDING AND OTHER EQUIPMENT 


237 


Other General Equipment 

The theory of other property accounts which, for the 
sake of financial statements, may be grouped under this 
title, such, for instance, as Fire Apparatus, Emergency 
Equipment, etc., is substantially the same as the theory 
of the account “Delivery Equipment/’ 


CHAPTER XXI 

MACHINERY AND TOOLS 


Classification of Machinery and Tools 

Although comparatively few concerns attempt to make 
their accounting differentiate the components of this ac¬ 
count, it may be better to subdivide the subject matter into its 
units which, for ordinary manufacturing businesses, may be 
substantially as follows: 

1. Machines; that is to say, such machines as are at¬ 

tached to the floor or to benches or to their bases 
by their weight only, or in such a manner as not to 
make them part of the building. 

2. Machine Tools. 

3. Shop and Hand Tools. 

As opposed to the machine tool, the machine proper is 
that part of the whole apparatus which, by itself or through 
auxiliary devices, produces the required motion; the ma¬ 
chine tool, on the other hand, is the part of the machinery 
which performs the final function for which the apparatus 
as a whole was constructed. As to the hand and shop tool, 
it has nothing whatever to do with either. Taking as an 
example a milling machine, we find it defined in the “En¬ 
cyclopaedic Dictionary” as: “a machine for dressing metal 
work to shape, by passing it on a travelling-bed beneath a 
rotating serrated cylindrical cutter.” In a machine of this 
type the part of the apparatus which produces the motion 
necessary to carry the object to be dressed in the proper 
position under the cutter, is the machine proper, whereas the 
cutter is the machine tool. 


238 





MACHINERY AND TOOLS 


239 


The distinction may not appear important at first, but 
becomes so when it is considered that while the cost of the 
original tool equipment (which may comprise several cut¬ 
ters) is proportionately greater than that of the machine, 
the life of the machine may extend over a period of twenty 
years or more, whereas the cutter may be destroyed the 
first time it is used, either owing to a flaw in the material of 
which it is made, or through careless or faulty adjusting. 

Machine and Tool Accounting 

If the value of the machine and of the machine tools is 
stated in one account, and one of the cutters is destroyed, 
the account must be credited at once with the loss sustained; 
or the recording of the loss may be postponed until the tak¬ 
ing of the physical inventory at the end of the period; but 
in either case, the value of the machinery and tools asset 
must be reduced to the value of its remainder. This necessi¬ 
tates the keeping of a special machinery ledger containing 
an account with each machine. 

If, on the contrary, two accounts were created, one for 
machines and another for machine tools, a list of the ma¬ 
chines could be made once for all, stating the date at which 
they were acquired, their cost, their estimated life, their 
residual value, their factory number, their location on the 
floor of the plant, and the rate of depreciation which is ap¬ 
plied to each unit for purposes of reserves. This list would 
constitute a permanent inventory, subject only to additions 
and deductions due to the acquisition of new units or to the 
discarding of units whose life has expired. 

As to the machine tools, the fact that they are carried in 
a separate account makes it possible to place them in the 
custody of the storekeeper, to control their issue to the fac¬ 
tory, and to obtain a periodical book-inventory probably 
more valuable than a physical one, since it can be readily 
checked and priced. 


240 THE THEORY of the asset accounts 

Universal Machines 

In regard to machines, they may, if the occasion arises, 
be subdivided into two distinct accounts, one containing the 
value of the universal machines, the other the value of the 
special machines. 

Universal machines are those which are built according 
to a standard, and are used by all industries where the work 
to be performed calls for the application of familiar princi¬ 
ples of mechanics. Special machines, in contradistinction, 
are those which have to be constructed to meet the require¬ 
ments of special classes of industry, or of new manufacturing 
processes. Among the former may be mentioned drilling, 
cutting, milling, and grinding machines; a good illustration 
of special machines is afforded by the hydraulic diamond¬ 
headed filter through which, prior to the discovery of the 
wire-pulling process, the metal composition used in the man¬ 
ufacture of carbons for electric bulb-lamps was passed. 

Universal machines are generally purchased from con¬ 
cerns who deal in them because they are standardized arti¬ 
cles ; they are the best product of industry at the time they 
are acquired, and are subject to uniform prices. The value 
at which they are carried on the books is their original pur¬ 
chase cost as given by invoices, to which may be added 
freight and cartage, and the cost of installation and adjust¬ 
ing. The cost of subsequent changes and alterations which 
increase the efficiency or extend the life of the machines, may 
be capitalized. The credits to the account are for losses due 
to accidents which impair the usefulness of individual units, 
either in part or in full, and, at the expiration of the life of 
the machine, for their depreciated value as contained in the 

reserve for depreciation, and their residual scrap value. 

$ 

Special Machines 

Special machines are built either by machine shops, in 
accordance with designs and specifications submitted by the 


MACHINERY AND TOOLS 


241 


concern for whose account the construction is undertaken, 
or by the concern itself. In the former case, the value at 
which the machine is stated is the contract price; in the latter 
case it is the cost of material and labor, plus the freight 
and cartage on the material and a proper proportion of over¬ 
head expenses. In either case the cost of the experiments 
which were conducted before a desirable type was obtained, 
and the cost of the designs and patterns which were made, 
may be added to the value of the machine. The cost of all 
future improvements which make the machine more suitable 
to the requirements of the concern and increase its efficiency, 
may be added to the original cost. As to the question of 
increase of machine life, it is generally more than counter¬ 
balanced by the danger of obsolescence which is ever-present 
in this class of property. If a competitor develops a type 
which reduces the cost of manufacture, either by bringing 
about time-economy, or by making possible substantial 
changes in the process itself, the machine which is not 
capable of obtaining the same result must be discarded, irre¬ 
spective of its cost, and a more advantageous one built. 

Thus, we have in “special machines” an asset quite dif¬ 
ferent from the asset “universal machines.” One is subject 
to obsolescence, and the other is not; the cost of one is cer¬ 
tain and its components are well known; the cost of the other 
is uncertain, and the proof of the accuracy of its stated value 
is not readily obtained. Barring accidents, one will be in 
service for a known number of years; under the same condi¬ 
tions, the extent of the other’s useful life is problematic. 

Depreciation 

Without attempting to go deeply at this point into the 
subject of depreciation, which will be considered in subse¬ 
quent chapters, it is evident that the irreparable wear and 
tear sustained by universal machines, either as a result of 
manufacturing, or through the mere efflux of the term of 


242 THE theory of the asset accounts 

their useful life, is quite different from the possibility of 
loss through obsolescence which is found in special machines. 
If, then, the asset which is to be depreciated is composed of 
the two distinct types, the reserve for depreciation will also 
contain two kinds of losses, i.e., one which is probable and 
one which is problematic. It seems, under the conditions, 
that the purpose of accounting would be better served if the 
two types of machines were kept separate. 

Shop and Hand Tools 

The nature of the asset “shop and hand tools” is so 
different from that of the two elements of machinery and 
tools already mentioned, that it should under all conditions 
be stated by itself. The tools contained in this account are 
sometimes referred to as “small equipment.” They com¬ 
prise saws, files, hammers, screw-drivers, etc., which on ac¬ 
count of their fragility, their size, the manifold uses to which 
the}) are placed, and the facility with which they can be 
passed from hand to hand and from bench to bench, cannot 
be readily or accurately inventoried. They are generally 
kept under the custody of a storekeeper, and charged to cost 
of manufacture when issued to the factory. In some cases, 
they are consigned to the workingmen, and submitted peri¬ 
odically to the inspection of the storekeeper; at this time, the 
broken and worn-out tools are charged to the cost of manu¬ 
facture, and the cost of the tools lost is charged to the wages 
of the careless workmen; in either case, credit is given to 
the general ledger account containing their value. Which¬ 
ever way they are treated, they are not subject to depre¬ 
ciation. 


CHAPTER XXII 


GOOD-WILL, PATENTS, TRADE-MARKS, COPY¬ 
RIGHTS, FRANCHISES 

GOOD-WILL 

Definition 

One of the most commonly quoted definitions of good¬ 
will, so far at least as accountants are concerned, is the one 
given by Lisle in his book “Accounting in Theory and Prac¬ 
tice’ ’: “Good-will is the monetary value placed upon the 
connection and reputation of a mercantile or manufacturing 
concern, and discounts the value of the turnover of a busi¬ 
ness in consequence of the probabilities of the old customers 
continuing.” 

Another definition is the one appearing in the opinion of 
Lord Elton in the English case of Crutwell v. Lye, which 
is about one hundred years old: “The good-will which has 
been the subject of a sale, is nothing more than the prob¬ 
ability that the customers will resort to the old place.” 

Lord Elton’s definition gives the impression that good¬ 
will is a purely local matter, and that if a concern having 
acquired the business of another, subsequently transfers it 
to a different locality, it loses the right to expect that the 
old customers will continue. This is indeed the stand taken 
by a Pennsylvania court in the case of Elliot’s appeal (60 
Pa. St. 161) in which it was held that the good-will of an 
inn, or tavern, did not exist outside of the premises where 
the business was conducted at the time of the sale. 

Lord Elton’s definition has, however, been the subject of 

243 


244 THE THE0RY 0F THE ASSET accounts 

much criticism in and out of American courts, owing to its 
narrow conception of the valuable asset “good-will.” Nor 
does it seem that English courts have shared his views. 
Vice-Chancellor, Sir W. Page Wood, says: “Good-will, I 
apprehend, must mean every advantage * * * that has been 
acquired by the old firm in carrying on its business, whether 
connected with the premises in which the business was previ¬ 
ously carried on, or with the name of the late firm, or with 
any other matter carrying with it the benefit of the business.” 

Personal Character of Good-Will 

Purely local as the character of good-will is under cer¬ 
tain conditions (as for instance in the case of a hotel whose 
attractive and convenient location is primarily responsible 
for the vogue which it enjoys) it may be said to be more 
commonly personal. If Steinway and Sons were to sell their 
' business and their name to a firm who found it advisable to 
transfer the plant and the selling agency from New York 
to Boston, it is certain that the good-will of the musical 
world would not be affected by the change. 

It is precisely that element of personality possessed by 
good-will which links it so naturally to types of organiza¬ 
tion in which the names of the supposed proprietors are 
known, that is to say, sole proprietorships and copartner¬ 
ships. It is also on this account that the courts have ruled 
that the good-will of a partnership does not inure to the 
benefit of the surviving partners, but belongs to the pur¬ 
chaser of the firm name,* and that the good-will of a market 
stand or stall the lessee of which has died, is independent of 
the stand itself and belongs to the estate of the deceased.! 

Good-will is very frequently referred to as an “intangible 
asset,” that is to say, something the existence of which is 
spoken of, but is not palpable. Intangible as it may be by 


* Slater v. Slater, 175 N. Y. 143 (1903). 
t Journe’s Succession, 21 La. Ann. 391. 



GOOD-WILL 


245 


itself, it must nevertheless rest upon something tangible; it 
is not conceivable, for instance, that a skilled surgeon whose 
fame is far-reaching could sell the good-will of his practice 
to an unknown confrere whose skill has yet to be demon¬ 
strated. There is nothing tangible in the assurance of the 
vendor surgeon that his patients will be willing to intrust 
their lives to his successor. Good-will- in this case is non¬ 
existent as a marketable value, since it depends upon per¬ 
sonal skill which is not to be acquired through purchase. On 
the other hand, a physician practising without competition 
in a rural district could in all propriety place a value on the 
good-will of his practice, provided he were to agree to 
recommend the purchaser to his patients as fully capable of 
giving them equally skilled service, and agree to retire, or 
to move to another state or to another part of the same 
state. Good-will in this case would rest upon the monopo¬ 
listic prerogative of the vendee. This is so true that if the 
vendor subsequently performed an act which would tend to 
defeat the certainty of monopoly now possessed by the 
vendee, such, for instance, as announcing the resumption of 
his practice in the field of his former activities, the courts 
would invalidate the contract and relieve the aggrieved 
vendee of his obligations under the contract of sale.* 

The Good-Will of Corporations 

The nature of the good-will of corporations may be quite 
different from that of the good-will of sole proprietorships 
and of copartnerships. When corporations sell their assets 
it often happens that the identity of the vendor is lost in 
that of the vendee. In this case the purchaser does not 
acquire the right to expect that the customers of the vendor 
will resort to the old place. He acquires the earning power 
of an established business whose products will sell, no matter 
who offers them for sale; he figures that, with more up-to- 


* Townsend v. Hurst, 37 Missouri 679. 



246 THE THEORY OF THE ASSET ACCOUNTS 

date methods of conducting the business, and through the 
application of scientific economy, and the union of forces 
hitherto antagonistic, larger profits will be obtained than 
were possible before the consolidation of interests took place. 
For this, he is willing to pay a sum of money which may be 
far in excess of the properties acquired. 

In the absence of a better term, accountants, as well as 
laymen, are generally satisfied to call this excess price good¬ 
will ; but the frequency with which the excess of cost over 
the intrinsic value of the properties acquired is distributed 
by boards of directors over the value of the individual prop¬ 
erty units included in the purchase, no mention whatever 
being made of good-will, indicates that there is some deep- 
rooted objection to the term, at least from the point of view 
of corporations. 

There are, in fact, any number of instances of consolida¬ 
tions of corporations where the application of the word 
good-will to the excess price paid by the consolidating in¬ 
terests over the intrinsic value of the properties acquired, 
would be equivalent to an attempt to mislead, or to an ad¬ 
mission of ignorance of the conditions which brought about 
the combination. The earning power of, say, three corpora¬ 
tions to be consolidated may have been reduced to a negli¬ 
gible quantity by the keenness of the competition in which 
they have engaged. If that earning power were to be used 
as the basis for the computation of the value of good-will in 
accordance with the rules which are said to prevail in such 
cases, there would remain a minus quantity to express the 
good-will valuation. And, yet, the stockholders of the three 
competing companies may not feel disposed to combine un¬ 
less they receive a considerable amount over the intrinsic 
value of the properties which they control. Thus, so far as 
earning power is concerned, the bonus paid does not apply 
to past performances but to confidence in the future. If the 
word good-will applies to anything, under these conditions, 


GOOD-WILL 


247 

it must be to that harmony which the consolidation has 
brought about among forces which up to now were only 
desirous of destroying one another. 

# 

Good-Will as an Asset 

It should be said, however, that while any reference to 
good-will may properly be eliminated from the books of a 
corporation which absorbs other interests in such a manner 
as to cause the identity of the vendor to be entirely lost, it 
should be retained as an asset of a corporation which takes 
over a copartnership or a sole proprietorship, particularly 
when the vendee concern retains enough of the name of the 
vendor to preserve the personal character of the good-will 
purchased. 

The importance of the asset “good-will” when it has 
been acquired by purchase, cannot be overestimated. There 
is no other asset of a concern the sale of which would be so 
effective in bringing operations to an end. In some instances 
it has been held by courts of law that under the terms of a 
contract for the sale of good-will, the vendor has no subse¬ 
quent right to solicit trade in the section of the country in 
which he previously operated, even among people who were 
not his customers at the time of the sale.* The sale of good¬ 
will may even prevent an individual from using his own 
name in connection with the line of business in which he has 
engaged prior to the sale. Judge Batesf quotes a case in 
which Beatty and Gage formed a partnership whose most 
valuable asset was a series of copy books, known as “Beatty’s 
Head Line Copy Books.” They dissolved, Gage buying out 
Beatty’s interest for $20,000. It was shown that a large 
part of the price was for the right to sell the copy books. 
A publishing company, with Beatty’s assistance, got out a 
new series called “Beatty’s New and Improved Head Line 


* Munsey v. Butterfield, 133 Mass. 492. 
t “Law of Partnerships. ” 



248 THE theory of the asset accounts 

Copy Books.” This was held to be an infringement of 
Gage’s rights, the word Beatty as applied to the books 
being a valuable asset which passed to Gage.* 

Depreciation of Good-Will 

Why good-will, having been acquired at a cost which is 
sometimes considerable, and constituting in some instances 
the only truly valuable asset of a concern, should be out¬ 
lawed and sentenced to gradual expulsion from respectable 
books, is one of the perplexing puzzles which accounting 
offers to its students. Accountants who would never permit 
the reduction of a physical asset by the estimated amount of 
depreciation which it may or may not have suffered during 
a given period, have no scruples at all when it comes to good¬ 
will. Still, it seems that if a concern has paid a large sum 
to acquire the good-will of another, and has not only re¬ 
tained it but even increased it, there is no apparent reason 
why so-called conservatism should demand the writing off 
of the asset to the detriment of the very profits which its 
purchase gave the right to expect. 

One of the reasons frequently advanced in favor of this 
writing off policy, is that the valuation of good-will, being 
based on a given number of years’ purchase of the average 
net profits of the vendor concern, less a fair return on capi¬ 
talization, its cost is consumed concurrently with the efflux 
of the period for which it has been purchased. This is, in¬ 
deed, an extreme view. It is unequivocally expressed in 
Clarence Munro Day’s “Accounting Practice” : “Good-will 
is a legitimate asset in an industrial enterprise and the most 
accepted method of computing the amount of good-will is 
to take the total profits for the last five years and deduct 
from them five years’ interest on the capitalization at seven 
per cent per annum; the balance is good-will. The rate of 
interest is based on the assumption that no capitalist would 


* Gage v. Canada Publishing Co., xi Ont. App. 402. 



GOOD-WILL 


249 


invest in an enterprise unless he was assured at least seven 
per cent annual return. Good-will should be written off the 
books during five subsequent years by charging off one-fifth 
against each succeeding year.” 

As opposed to this view, which we have qualified as 
extreme, the following quotation from Dicksee’s “Auditing” 
may be of interest: “Good-will does not depreciate. On 
the other hand, it will generally be conceded that it is liable 
to fluctuations, both continual and extreme * * * As a 
matter of fact, good-will is not written down because its 
value is supposed to have become reduced—such a course 
is all but unknown. The amount at which good-will is 
stated in a balance sheet is never supposed to represent 
either its maximum or its minimum value; no one who 
thought of purchasing a business would be in the least 
influenced by the amount at which the good-will was stated 
in the accounts; in short, the amount is absolutely meaning¬ 
less, except as an indication of what the good-will may have 
cost in the first instance. Inasmuch, therefore, as nobody 
can be deceived by its retention, there is no necessity for the 
amount of good-will account to be written down. On the 
other hand, the practice is not unusual, where sufficient 
profits are being made. The question is not, however, one 
upon which the auditor is required to express an opinion.” 

Creation of Good-Will 

It is generally recognized that the question of the value 
of good-will does not arise until a sale is contemplated. 
Thus, it does not seem possible for a concern which has or¬ 
ganized otherwise than by purchase of an already established 
business, to create the asset “good-will” during the course of 
its operations as a going concern. Still, if it is considered 
proper to set aside the expenses of organization in an ac¬ 
count which will be reduced periodically during the years to 
which the benefit derived therefrom applies; if further, it 


250 THE theory of the asset accounts 

is agreed that corporations have the right to spread the loss 
incurred through discounts on bonds over the life of the 
bonds, there does not seem to be a valid objection to the 
charging of the operating shortcomings of what might be 
called the “probation period” of a newly established business 
to an account which would record the cost of obtaining the 
good-will of the community. 

We often hear of concerns which expect to lose money 
during the first five years of operation, owing to the heavy 
advertising which they will have to do in order to call the 
public’s attention to the value of their goods. If the cost of 
such advertising is charged to expense, together with other 
lavish expenditures which a newly established business is 
bound to make at the start to win the favor of those whom 
curiosity first attracts to the establishment, a considerable 
deficit may be shown. Would it not be better to raise an 
account with good-will, which would be made to reflect the 
extraordinary cost of establishing the business, and to dis¬ 
tribute that cost over the future periods which are to be 
benefited thereby? 


PATENTS 


Nature of Patents 

Black’s Law Dictionary defines a patent: “A grant made 
by the Government to an inventor conveying and securing 
to him the exclusive right to make and sell his invention for 
a term of years.” Thus, a patent is nothing short of a 
monopoly granted by the State, presumably as an induce¬ 
ment to the inventor to disclose the secret of his invention 
for the benefit of the public at large. The territory over 
which the monopoly extends is mentioned in both the letters 
patent issued to the inventor and in the statute authorizing 
the issue of patents. United States patents apply to all the 
states and organized territories, as well as to American ves- 


PATENTS 


251 


sels on the high seas. They do not, however, apply to 
foreign vessels in American ports. In certain foreign coun¬ 
tries—England, for instance—a patent which has not been 
operated for four years may be revoked, but in the United 
States the right of the patentee is not thus affected. In 
England, the Crown reserves the right to use the patented 
invention in return for fair compensation; while the United 
States Government does not reserve that right to itself. 
However, no injunction can be obtained against the Govern¬ 
ment, and it is within its power to use the invention by pay¬ 
ing therefor reasonable fees to the inventor. 

In the United States the term of a mechanical patent is 
seventeen years from the date of grant; the term of a design 
patent is three years and one-half, or seven years, or four¬ 
teen years, according to the application. In England the 
patent expires with any foreign patent granted before the 
English patent; in Canada it expires with any foreign patent 
granted during its life. In the United States a patent can 
be extended by special act of Congress. 

Treatment of Patents 

The value at which the asset '‘patents” is carried on the 
books, depends upon whether the concern which owns it is 
the inventor, or has acquired it from the inventor. In the 
former case, its value is the cost of conducting the experi¬ 
ments which have led to the invention, and the fees paid in 
connection with the search as to the validity of the claim for 
the patent, and with the filing of the claim. In the latter 
case its value will, of necessity, be what the concern paid 
for it. 

Since patents grant what may be termed a legal monop¬ 
oly, it is clear that they convey a sort of a title to the good¬ 
will of the community in which the right to exclude every¬ 
body except the Government from the use of the invention 
is exercised. This is why so many corporations which ac- 


252 THE THEORY OF THE ASSET ACCOUNTS 

quire the business of other concerns where a patent is in¬ 
cluded among the assets, carry the excess price paid over the 
intrinsic value of the property acquired, under the term 
“Patents and Good-Will,” or merely spread it over the value 
of the patents. 

If the monopoly granted by the patents lasts only for a 
term of years, it would seem that the asset should be written 
off during the life of the grant. This can be done in two 
ways: 

1. Credit Patents and debit Profit and Loss with equal 

instalments corresponding in number to the number 
of years during which the patent continues to be 
operative. 

2. Credit Patents, or Reserve for Amortization of 

Patents, and debit one of the components of the 
cost of goods sold, with periodical amounts repre¬ 
senting the probable royalty which would have to 
be paid on the sales if the patents were operated on 
a royalty instead of owned. If the reserve account 
has been created, debit it and credit Patents as soon 
as the two accounts are equal in amount. 

It will be noticed that the second method makes the cost 
of manufacture bear the loss sustained through the natural 
extinction of the very asset which made operations possible 
and created a legal monopoly; further, that it leads to the 
peculiar conclusion that the income from sales becomes 
larger as soon as the asset “Patents” has been eliminated. 
When speaking of the statement of income we shall have 
occasion to refer again to the oddity of accounting conclu¬ 
sions to which we are led by certain accounting theories and 
methods. 

It should be stated that, instead of being written off, 
patents have frequently been appraised on the basis of the 
saving in royalties which their possession affords, precisely 


TRADE-MARKS 


253 


like water-power rights have been appraised on the basis of 
the saving in fuel and power-producing machinery effected 
by the use of natural forces. 

There exists another theory to the effect that while it is 
true that patents expire within a certain number of years, 
the benefit derived from them by the business does not ex¬ 
pire concurrently. It is pointed out that the species of 
monopoly granted by patents is bound to create a consider¬ 
able amount of good-will, the existence of which is appre¬ 
ciated by would-be competitors, and deters them from 
engaging in a line of business which has been for so many 
years the exclusive domain of an established concern. Un¬ 
der this theory, it would be possible to retain the asset value 
of a patent long after its legal termination, by transferring 
this value to the Good-will account. 

TRADE-MARKS 

Definition 

A trade-mark is nothing more than a conventional sign 
which, for commercial purposes, has the same effect as the 
signature has upon a written document; they both certify 
to the origin or authorship of the thing to which they are 
appended. 

Trade-marks make it possible for their owners so to 
earmark their goods as to make them easily recognizable by 
buyers; in other words, they guarantee that whatever good¬ 
will attaches to the product, will be certain to revert to the 
proper party. In the case of Liedersdorf v. Flint,* it was 
said: 

“The court proceeds upon the ground, that the com¬ 
plainant has a valuable interest in the good-will of his trade 
or business, and that having appropriated to himself a par- 


* 15 Fed. Cases 219 (Note 8). 



2 54 


THE THEORY OF THE ASSET ACCOUNTS 


ticular label, or sign, or trade-mark, indicating that the 
article is manufactured or sold by him or by his authority, 
or that he carries on his business at a particular place, he is 
entitled to protection against any other person who pirates 
upon the good-will of his customers or of the patrons of his 
trade or business, by sailing under his flag without his 
authority or consent.” 

Since an unauthorized use of trade-marks constitutes an 

* 

infringement of the owner’s right to exclusiveness, it may be 
said of them that they confer a monopoly different from the 
one obtained under patents, in that its duration is not limited 
by statute, and can be exercised as long as one desires to use 
the marks for trade purposes. Thus, the main distinction 
between patents and trade-marks is that the former need not 
be used to remain in force, whereas the latter must be used 
or the owner’s exclusive right to them is lost. 

While the cost of trade-marks may be insignificant when 
acquired otherwise than by purchase from former owners, 
their value may be considerable, because the very success of 
the goods which they protect means the acquisition of the • 
good-will of the trade to which these goods are offered for 
sale. If trade-marks have been acquired from another con¬ 
cern their cost may be high, owing to the good-will which 
they convey. No matter what their cost may be, their in¬ 
fluence upon the prosperity of the business is so well defined 
that they are entitled to a place among the invested values 
of the enterprise. If kept in force, their value should not 
be written off. If abandoned, they may be closed by debit 
to profit and loss, precisely like all other assets which have 
outlived their usefulness; or they may be written off gradu¬ 
ally during a period of years, upon the theory that although 
given up, they have brought good-will to the business of 
future years; or again, their original cost may be transferred 
to the good-will to be written down with that asset, if such 
is the policy of the concern. 


COPYRIGHTS 


255 


COPYRIGHTS 

Definition 

Bouvier’s Law Dictionary defines copyrights as “the ex¬ 
clusive privilege, secured according to certain legal forms, 
of printing, or otherwise multiplying, publishing, and vend¬ 
ing, copies of certain literary or artistic productions.” 

In the United States, to be entitled to a copyright one 
must make application therefor, remitting at the same time 
the required fee, and cause to be delivered to the Library of 
Congress two copies of the work. 

Like trade-marks and patents, copyrights give a monop¬ 
oly; but in their case the privileges is limited to a term of 
twenty-eight years from the time of recording. The term 
can be extended for twenty-eight years, upon request by the 
author, his widow, or his children, within one year after the 
termination of the original grant. This privilege does not 
extend to the assignee, unless so provided in the contract of 
assignment. 

Copyrights are personal property; as such, they may be 
willed ; in the absence of a will, they descend to the natural 
heirs. 

The nature of the species of monopoly granted by copy¬ 
rights, consists in the privilege enjoyed by the owner or his 
assignee or full licensees, to prevent any unauthorized sale 
of the copyrighted works, and the publication of mutilated 
parts thereof. 

Copyrights as an Asset 

The question of the value of the asset “copyrights” is 
a complicated one. The original cost of obtaining the grant 
is insignificant unless the value of the time consumed in the 
preparation of the work be capitalized, together with the 
expenses incident thereto and with the cost of such prelim¬ 
inary advertising as may have been deemed necessary. 


256 THE THEORY OF THE ASSET ACCOUNTS 

In the case of copyrights which are valuable only to the 
original grantee, such, for instance, as catalogues, price 
lists, and advertisements, the cost of plates, etchings, half¬ 
tones, etc., may be added to the value of the asset as stated 
above. But in the case of assignable copyrights, the plates, 
etchings, and half-tones are so independent of the right it¬ 
self that they can be sold without giving the purchaser the 
slightest claim upon the copyright unless so provided in the 
contract. 

The probable value of assignable or salable copyrights 
depends, to a great extent, upon an estimate of the vogue 
which they will enjoy; their real value depends upon past 
performances so far as public favor is concerned, as well as 
upon an estimate of the continuation of their vogue. 

Copyrights, being a monopolistic grant, raise naturally 
the question of good-will. A copyrighted work may have 
been a financial failure and yet have obtained an artistic 
success such as to lift its author and its publishers to a very 
high plane in the favor of a certain class of readers. If the 
defects which made it commercially unprofitable can be 
remedied in future works of the same author, the good-will 
which the first production has acquired may enhance greatly 
the commercial success of subsequent copyrights. Hence, 
the losses sustained by the poor seller might be capitalized 
under the name of good-will, or added to the value of the 
copyright, at least until such time as the retroactive effect 
of subsequent successful works upon the unsuccessful one 
has been ascertained. 


FRANCHISES 

Definition 

Franchises have been defined as “a branch of the sov¬ 
ereign power of the State, subsisting in a person or in a 
corporation, by grant from the State/’ This definition has 


FRANCHISES 


257 

been assailed, upon the ground that it fails to establish a 
proper distinction between “primary franchises” and “sec- 
ondary franchises.” 

Primary Franchises 

Primary franchises are special privileges, not generally 
possessed by individuals, which are granted by the State 
pursuant to a well-defined policy of government or of busi¬ 
ness control. They include : the right of perpetuity of pur¬ 
pose and of life, which corporations obtain by virtue of their 
charter; the privilege of limited liability which certain forms 
of organization receive from the State, as well as all the 
other special privileges which their legal status conveys, and 
the rights and prerogatives which all citizens enjoy under 
existing statutes, or in accordance with the spirit of the 
common law. 

Secondary Franchises 

Secondary franchises, at least under the American sys¬ 
tem of government, originate through a contract made upon 
valuable consideration, between the sovereign power and in¬ 
dividuals or corporations. The consideration for the con¬ 
tract may be monetary, or it may be only the public value of 
the services to be rendered by the party seeking the grant. 
They include, in the language of the Supreme Court: “rights 
and privileges which are essential to the operations of the 
corporation, and without which its road and works should 
be of little value; such as the franchise to run cars, to take 
tolls, to appropriate earth and gravel for the bed of its road, 
or water for its engines, and the like.”* 

The main distinction between the two classes of fran¬ 
chises, so far as organized business bodies are concerned, is 
that the former (primary) cannot be alienated, assigned, 
mortgaged, or otherwise disposed of, while the latter (sec- 


* Morgan v. Louisiana, 93 U. S. 217; 23 L. Ed. 860. 



258 THE theory of the asset accounts 

ondary) may be, if proper authorization is given by the 
sovereign power which made the grant. 

Generally speaking, secondary franchises are monopolis¬ 
tic and permanent rights “to do an act, or a series of acts 
of public concern.” 1 They constitute a contract between the 
grantor and the grantee, which cannot be revoked unless the 
grantor specifically reserves to himself the right of revo¬ 
cation. 

The characteristic feature of franchises is that they must 
be granted by a sovereign power. Under this interpretation 
of the nature of the grant, it has been claimed that the 
privileges conferred by the municipalities are not franchises 
but merely licenses. 2 On the other hand, it has been held 
that if the grantee of the municipal licenses has given ade¬ 
quate consideration (such as a promise to pay to the munici¬ 
pality a certain proportion of its earnings or of its net 
profits), the grant ceases to be a license and becomes a fran¬ 
chise which is in the nature of a binding contract and cannot 
be revoked at the will of the grantor. 3 

The legal doctrine which attempts to establish a differ¬ 
ence between the franchises granted by a state and those 
granted by municipalities, is generally thought to be un¬ 
sound, upon the ground that municipalities, being state cor¬ 
porations and part of the body politic, are mere subdivisions 
of the sovereign power. The question as to whether or not 
the grant of a franchise by a city is an infringement of the 
right of the state, appears to be one of legal proceedings, 
and not a question of fact. 4 

Charges Against Franchises 

In connection with the components of the book value of 
the asset “Franchises,” when possessed by public service cor- 

1 Southampton v. Jessup, 162 N. Y. 122, 126; 56 N. E. 538. 

2 Chicago City R.R. v. People, 73 Ill. 541. 

3 Chicago Municipal Gas Light, etc., Co. v. Lake, 130 Ill. 42; 22 N. E. 616. 

* East Cleveland R.R. Co., 6 Ohio Cir. Ct. 318. 



FRANCHISES 


259 

porations, the Public Service Commission of the first district 
of the State of New York has ruled: 

“To this account shall be charged ‘the amount (exclu¬ 
sive of any tax or annual charge) actually paid to the state 
or to a political subdivision thereof, as the consideration for 
the grant of such franchise or right’ (Section 55 of the 
Public Service Commission Law) as is necessary to the 
conduct of the corporation. If any such franchise is ac¬ 
quired by assignment, the charge to this account in respect 
thereof must not exceed the amount actually paid therefor 
by the corporation to its assignor, nor shall it exceed the 
amount specified in the statute above quoted. Any excess 
of the amount actually paid by the corporation over the 
amount specified in the statute, shall be charged to the ac¬ 
count ‘Other Intangible Street Railway Capital.’ If any 
such franchise has a life of not more than one year after the 
date when it is placed in service, it shall not be charged to 
this account but to the appropriate accounts in ‘Operating 
Expenses,’ and in ‘Prepayments’ if extending beyond the 
fiscal year. 

“Payments made to the State or some political subdivision 
thereof as a consideration for granting an extension for 
more than one year of the life period of a franchise shall be 
classed as renewals. Those made as a consideration for 
franchises or extensions thereof covering additional territory 
to be operated as a part of an existing system shall be classi¬ 
fied as betterments. If the franchises cover separate and 
distinct new enterprises, the payments therefor shall be 
classed as original. 

“Note: Annual or more frequent payments in respect of 
franchise must not be charged to this account, but to the 
appropriate tax or operating expense account.” 

This debars a public service corporation which falls un¬ 
der the commission’s supervision, from charging to the 


26o THE theory of the asset accounts 


account “Franchise” the cost of obtaining the consent of the 
property owners, and the cost of the legal expenses incurred 
in connection with obtaining the grant. Generally speaking, 
however, such expenses are thought to be properly capital¬ 
ized under the heading “Franchises,” by companies not con¬ 
trolled by the commission, together with the consideration 
for the contract between the grantor and the grantee, i.e., 
the amount paid to the state or political subdivision thereof. 
As to the propriety of capitalizing legal expenses, the ques¬ 
tion remains an open one; some accountants claim that such 
capitalization is faulty whenever the company which is the 
beneficiary of a franchise, has a permanent legal department 
as part of its administrative organization. 

Any other cost incident to, or necessary for, the enjoy- 
?nent of the franchise, such, for instance, as the cost of 
paving between tracks, may be capitalized in some other 
property account, such as Paving, Track and Roadway, etc. 

The payment to a municipality of a portion of the earn¬ 
ings from operations, in accordance with the terms of a 
franchise grant, is considered as a burden of the asset and 
cannot enter into its valuation. 


CHAPTER XXIII 


INVESTMENTS 


Surplus Capital 

That part of the capital of a business which is not re> 
quired for the operation of the enterprise, may be invested 
outside the business in such a manner as to' provide an in¬ 
come at least equivalent to the returns which a private in¬ 
dividual may expect to receive from his wealth through 
ordinary investment channels; also, profits which have come 
in the business and are not needed for additions and better¬ 
ments, for extension of the field of operations, or for dis¬ 
tribution to the interested parties, may be similarly used. 
This is done in order to obtain an income through sources 
which the legitimate pursuits of the enterprise do not afford. 
Finally, all available funds of the concern, whether capital 
or the result of operations, may be invested for the produc¬ 
tion of the income necessary to fulfill the purpose for which 
the concern was organized. 

Speculative Investments 

Investments may be temporary or permanent in nature. 
If temporary, they may have an undercurrent of speculation 
which should not be present in permanent investments. A 
business concern having unemployed funds, may afford to 
invest in securities selling below their acknowledged or sup¬ 
posed worth, hold them until market conditions improve, 
and sell them in order that the profits may be realized. But 
a life insurance company, whose duty it is to obtain for the 

261 


262 THE THEORY OF THE ASSET ACCOUNTS 

present and secure for the future an income of such magni¬ 
tude that it will not only exceed the cost of conducting the 
enterprise and provide for such losses as may be incurred, 
but provide as well for the largest possible refunds of pre¬ 
miums to the policy holders in the form of dividends, cannot 
afford to buy securities the fluctuations of which may be due 
to the uncertainty of the income to be derived from them, 
or to the problematic character of their value in the event 
of the dissolution of the companies issuing them. 

Temporary investments may include, among other 
things, securities owned, securities purchased on margin, 
and goods purchased owing to unusually favorable market 
conditions and held either to be used by the concern itself, 
if conditions make it advisable, or to be sold if prices rise 
to a figure which will guarantee a larger profit than could 
be had if the goods were to be used by the concern. 

Securities purchased for speculative purposes should be 
carried on the books at their original cost, that is to say, at 
their market value on the day of the purchase, plus fees re¬ 
quired by law or custom, and charges for services rendered 
by the agents who attended to the purchase. When pur¬ 
chased on margin, they should be carried at cost, that is to 
say, market value on the day of purchase, plus charges inci¬ 
dent thereto, plus subsequent charges made by brokers for 
interest on the proportion of the cost which the margin does 
not offset, less, if such accrue, any dividends or interest col¬ 
lected by the broker for the account of the legal owner of the 
securities. To offset the excess of the original cost over the 
'amount of the margin and the subsequent additions to, and 
deductions from, that excess, the account with the broker is 
credited or debited, as the case may be. The account is also 
debited with all payments made to the broker subsequent 
to the purchase. Thus, the equity of the speculator is 
represented by the difference between the asset and liability 
accounts. 


INVESTMENTS 


263 


The theory which holds that securities carried for specu¬ 
lative purposes should be stated at cost, is often objected to 
on the ground that, since speculation is involved, it is well 
to make the Investments account reflect the fluctuations of 
the market. It cannot be forgotten, however, that nothing 
which has not been sold can bring profits, and that the 
Profit and Loss account is not intended to reflect what the 
profits or the losses would be if certain transactions had 
taken place, but what they are as a result of the transactions 
which have taken place. 

Goods acquired for speculation should be carried at cost 
of purchase, plus charges Tor brokerage, cartage, storage, 
etc., and plus the subsequent cost of holding them. 

Permanent Investments 

The word “permanent” when applied to investments, 
does not mean that the funds are invested forever in one 
particular thing, but that if the sum which has been invested 
is returned at the expiration of the term of the investment, 
it will be reinvested at once, or as soon as may conveniently 
be done. Permanent investments may be divided as follows : 

1. Loans Secured by Bonds and Mortgages 

2. Loans Secured by Collateral 

a. Time Loans 

b. Call Loans 

3. Investments in Bonds of Other Companies 

4. Investments in Stocks of Other Companies 

5. Investments in Real Estate 

1. Loans Secured by Bonds and Mortgages 

The account representing this type of investments is 
frequently found under the name “Mortgages Receivable.” 
In connection with the word “mortgage,” as usually em¬ 
ployed, F. A. Cleveland says in “Funds and Their Uses” : 

“That which commonly goes in the security market as 


264 THE theory of the asset accounts 

‘mortgage/ is a misnomer; it is in reality a credit obligation 
secured by a mortgage * * * in fact, if one held only 

the ‘mortgage’ or security contract, it would be of little 
value. The promise for the delivery of money is found in 
a ‘promissory note’ or other evidence of debt. The mortgage 
is only a collateral contract which gives to the creditor a 
contract of lien on the property named as security for the 
payment of the contract of credit.” 

The Mortgage Contract 

The indenture pledging property to secure the loan re¬ 
ceived by the mortgagor may, or may not, mention the 
right of the mortgagee to pay delinquent taxes on the 
property pledged, or such assessments levied on the prop¬ 
erty as the mortgagor may fail to pay, or fire insurance 
premiums which he is in duty bound to pay and has not 
paid; nevertheless, the mortgagee has that right, and such 
payments made by him will be presumed to be for the 
benefit or protection of the pledge. The payments thus made 
will be added to the principal of the loan, and be covered 
by the pledge, precisely as if they had been part of the 
original sum loaned. This applies also to the necessary 
expenses of the mortgagee in connection with foreclosure 
proceedings. By necessary expenses is meant disbursements 
which cannot be construed as being incurred merely for the 
benefit and protection of the mortgagee. It has been held 
by courts of law that in the absence of stipulations in the 
pledge to the effect that the mortgagor is to bear cost, the 
recording fees cannot be charged against him.* This is due 
to the fact that the recording of a mortgage is principally for 
the protection of the mortgagee, since, while an unrecorded 
mortgage is valid as between the contracting parties, it is 
invalid as against innocent third parties. 

To insure the permanency of this kind of investment, 


* Simon v. Sewell, 64 Ala. 241. 



INVESTMENTS 


265 

the mortgagee has been given the right to refuse repayment 
of the sum loaned until the date mentioned in the promissory 
note. To secure the recovery by the loaner of the principal 
sum loaned, of the advances made by him for the protection 
of the property pledged, and of the interest accrued there¬ 
under, the states of the Union have enacted statutes con¬ 
cerning the steps which the mortgagee must take to enter 
the premises or to satisfy his claim through foreclosure 
proceedings. 

Mortgage Interest 

In regard to the income from mortgage loans, it should 
be noted that it does not accrue from the date of the mort¬ 
gage, but from the date at which the money was paid to the 
mortgagor; that if no rate of interest is mentioned, the 
legal rate prevails; that if, peradventure, the bond or prom¬ 
issory note does not mention interest, while the mortgage 
does, interest will be allowed at the legal rate; that interest 
after the maturity of the obligation and default thereon, is 
chargeable to the mortgagor if the instrument so stipulates 
or if it carries interest “until paid.” 

The amount which will be loaned on bonds and mort¬ 
gages depends generally upon the margin considered to be 
safe. Some concerns will loan on first mortgages as much 
as 80% of the appraised value of the property to be pledged 
while others will loan only 60%. In the first instance the 
margin would be stated as 20% ; in the second, at 40%. 

Accounting Procedure and the Mortgage Register 

Accounting for this class of investments presents no 
difficulty so far as the general ledger is concerned, since it 
consists merely in recording the amount loaned, the ad¬ 
vances made for the account of the mortgagor, either at the 
time of the loan or subsequently, and the amount collected 
at maturity of the investment. But a subsidiary book which 


266 THE THEORY OF THE ASSET ACCOUNTS 


will give all the information that may be required, is a more 
complex matter. For each individual mortgage there must 
be known, besides the name of the mortgagor and the 
amount of the loan: the date when the mortgage was given 
and its maturity; the location and the general description of 
the premises mortgaged; the state and county, and the book 
and page, in which the mortgage was recorded; the interest 
rate and date; the number, the term, the amount, and the 
expiration of the policy of fire insurance which protects the 
buildings, the amount of the premium paid, the name of the 
company in which the property is insured, and the name of 
the party who is to pay the premiums; the appraised value of 
the land and of the buildings; the amount of principal repaid 
if the mortgage provides for gradual extinction, and the 
amount of interest accrued and due, as well as the amount 
paid. 

Figure 38 will show how the information required may 
be conveniently condensed without detracting from the 
lucidity of the record. Any other data which may be needed 
in regard to possible assignments of the mortgage, may be 
inserted on the left side of the folio. 

The Nature of Security 

“When a debtor delivers to his creditor an evidence of 
indebtedness with the intention that it become additional se¬ 
curity for his personal existing obligation, it becomes merely 
concurrent security, and is only designed to increase the 
means of the creditor to realize the principal debt which it 
is given to secure.”* 

“There are three kinds of security: the first, a simple 
lien; the second, a mortgage, passing the property out and 
out; the third, a security intermediate between a lien and a 
mortgage, viz., a pledgeTf The holder of a lien has no 


* Osborne v. Stringham, 44 S. D. 593, 598; 57 N. W. 776. 
t Halliday v. Holgate, L. R. 3 Exch. 299, 302. 



INVESTMENTS 


267 

right to sell the property which he holds as security; he 
must be content to retain it until his claim is satisfied. 

“A mortgage is but a conveyance with a clause of de¬ 
feasance; it is something more than a lien; it is the grant 
of an estate as specific security for the money loaned/’* The 
holder of a pledge has no title of any kind to the thing 


Date 

Recon 

Inhere 

IN5U 
Com 
Terr 
Polii 
Expt 
Amc 
Prer 
By vs 

APPE 

Lan 

Bull 

Nam 

Date 

((given 
l Due 

State 

• 

LOC 

Cit} 

5ta 

ATION 

/ 

Co 

5t 

SIC 

N« 

untry 

ged. 

, County 


reel 

J Book' 

. Page 

/ Pate 


Diagram and dimen 

>ns of property mortga 

5t l Date 

RANCE- 
pany 
n - 

:yJd&_ 

ration 




>unt & 


Amourrb $ 


mum © 

'horn payahle 

AI5AL5- 

d $ 

Mortgager. Name 

Address_ 

dings 4 


Remarks- 


of Appraisals 


Principal 

Interest 

Dr 

£r 

Date 

Accrued 

Gofiected 

Date 

Explanation 

Loan 

Advances 

Date 

Explanation 

Loan 

Advances 






















































































































































































Figure 38. Subsidiary Ledger for Secured Loans 


pledged, but has an implied right to sell it on the day of the 
default of the pledgor. “The authorities show that the 
difference between a pledge or pawn of personal chattels 
and a mortgage of them is, that a mortgage passes the whole 
legal interest and property from the mortgagor to the 


* Dateman’s Appeal, 127 Pa. St. 348; 17 Atl. 1086, 1100. 















































































268 THE theory of the asset accounts 


mortgagee, and possession by the mortgagee is not essential 
to create his title, and, generally speaking, is inconsistent 
with such a title, while a pledge transfers only personal 
property in the thing pledged, the general property con¬ 
tinuing in the pledgor. The pledgee’s right is not complete 
until he has obtained possession, and his right or special 
property is to hold the pledge as security for the debt or 
engagement of the pledgor, and on default on the day ap¬ 
pointed for payment or performance, to sell the pledge. Se¬ 
curities for money and negotiable instruments may be given 
in pledge, and the addition, as there is in the agreement here, 
of an express power to sell on default, will not change what 
would have been a pledge into a mortgage.”* 

The foregoing describes fully the nature of the asset 
“loans on collateral,” and differentiates between investments 
in which the title to the security pledged is in the loaner, 
although it carries a defeasance clause, and the investments 
in which the title to the pledge remains in the pledgor. 

2. Loans Secured by Collateral 

Time loans are made for a specified period of time, and 
cannot be repaid before maturity without the consent of the 
loaner; that consent may be given without consideration, 
or in consideration of the payment of a “bonus” calculated 
on the basis of equated time. 

Call loans are not made for any specific period, and are 
repayable at the option of the beneficiary or upon the de¬ 
mand of the loaner. 

The securities pledged under either class of loans may 
consist of bonds or stocks, or both, or even of goods de¬ 
posited in a warehouse, as evidenced by the pledge of the 
storage receipt. The pledge is, in any case, of a market 
value superior to the loan made thereunder. The amount 
of the margin depends upon the policy of the loaner as to 


* Dateman’s Appeal, 127 Pa. St. 348; 17 Atl. 1086, 1100. 



INVESTMENTS 


269 


what he considers safe. It is understood between the con¬ 
tracting parties that the securities pledged may be with¬ 
drawn at any time by the party who has title to them, and 
replaced by others equally acceptable to the pledgor. It is 
also understood that if the market value of the pledge falls 
below the margin represented by the difference between the 


Na 

Nam ®-- Terms. 

Address 

Amount t Dates; 

loan ♦ Loan 

Margin % Maturity 

Interest rate_ "A. Interest 

Remarks: 

Date 

Description 

Quan¬ 

tity 

Market 

Value 

Total 

Value 

Date 

Desription 

Quan¬ 

tity 

Market 

Vfelue 

Total 

Value 


































































































































































































Figure jp. Record of Collateral Pledged for Loans 


market value of the original securities on the day of the 
loan, and the amount loaned, the pledgee may call upon the 
pledgor for additional security sufficient to make up the 
difference, or, if it is a call loan, for additional security or 
for repayment. In case of default the pledgee may sell the 
securities, apply the proceeds to liquidate the indebtedness 


















































2jo THE THEORY OF THE ASSET ACCOUNTS 

of the pledgor, and, if any excess remains, return this to the 
pledgor. 

The method of keeping account of the collateral pledged 
under either time or call loans, is illustrated by Figure 39. 
Exchanges of securities are recorded by merely crossing off 
the particular items which have been removed, and entering 
under the proper date the securities which have taken their 
place. 

3. Investments in Bonds of Other Companies 

The accounting treatment here depends absolutely upon 
the purpose of the investment. 

If an '‘investment house” buys bonds, it is for the pur¬ 
pose of holding them until such time as they can be dis¬ 
posed of advantageously among customers of the house, or, 
if more profitable, resold in the open market. The only 
question at issue in either case is one of profit, and it is 
evident that, since par value is purchased and sold, with a 
variation in the amount of discount gained or premium 
suffered, the one important thing from the theoretical stand¬ 
point is to determine precisely that variation. 

Hence, so far as the general ledger is concerned, an ac¬ 
count with the par, and one with the premiums and dis¬ 
counts for every class of bonds acquired, will satisfy the 
requirements. The account with par is merely an inventory 
account reflecting at all times the unsold portion of the 
principal; the account with premiums and discounts is a 
complex account which, in order to show profits and losses, 
requires the application of the inventory of that part of the 
net amount of the account which applies to the principal 
unsold. 

The Interest Account 

Premiums and discounts must be carefully distinguished 
from the interest purchased, if any. Interest which has ac- 


INVESTMENTS 


271 


crued on the bonds at the time of their purchase is under 
no conditions to be considered as part of the cost of the 
investment. It must be evident to the student of accounting 
that the amount paid for interest accrued on bonds acquired 
does not represent either principal or income of the pur¬ 
chaser. It merely expresses the amount of the earnings of 
the vendor which the vendee will receive on the first interest 
date and must refund to the vendor in anticipation; or if the 
bonds are acquired from the company responsible for their 
issue, it represents only that part of the interest receivable 
at the first interest date, which the purchaser has not earned 
and which the issuing company has not incurred. As a 
consequence, interest accrued on bonds acquired, no matter 
what the purpose of the investment may be, is nothing more 
than interest purchased, for which a special account must be 
raised. This account will be closed, at the first interest date, 
by crediting to it that part of the interest receipts which 
was earned by the bonds before they were purchased, and 
which formed part of the purchase price. It is evident 
that this account does not reflect either a gain or a loss. 

The interest received on bonds by an investment house 
is, of necessity, income on the capital invested, and should 
under no conditions be considered as reduction of the cost 
of the investment. 

If a business concern buys bonds as temporary producers 
of income, the only logical way of treating the account is to 
express the bonds at cost. The question of amortization or 
of accumulation of cost to par cannot arise in this particular 
case, since it never was intended to hold the bonds until 
maturity. The receipts of interest will send to the earning 
account “Interest on Bonds,” an amount which will bear 
the rate of income which the concern expected on the cost 
shown by the bond account. When the securities are sold, 
the account with principal will reflect the profit or the loss 
made on the sale of the ledger asset. 


272 THE theory of the asset accounts 

Relation of Cost to Income 

If, in accordance with the purpose for which it was 
created, a concern purchases long-term investments in order 
that the rate of income which they produce may be guaran¬ 
teed for an extended future, then, and then only, does the 
accountant face the question of amortization of that part of 
the cost which will not be repaid to the purchaser at ma¬ 
turity, or the question of accumulation of that excess of par 
over cost which will be received at maturity of the invest¬ 
ment. 

This class of investment cannot be recorded otherwise 
than at the cost at the time of acquisition. By cost is meant 
only par plus premium or less discount, as the case may be, 
and, for reasons which will become obvious as soon as the 
theory of amortization has been expressed, cannot be made 
to contain interest purchased, brokerage, stamp tax, etc., 
etc. 

If the value of the asset is stated at cost, and cost is less 
than par, it is evident that at maturity of the investment, the 
amount of the principal received being credited to the asset 
account, the credit will exceed the debit, unless in the interim 
steps have been taken to accumulate cost to par. Conversely, 
if cost is greater than par, and at maturity of the invest¬ 
ment the amount of principal received is credited to the 
asset account, the debit will exceed the credit, unless in the 
interim steps have been taken to amortize the portion of cost 
in excess of par value. 

Now, since bonds assure to their holders an interest an¬ 
nuity during the life of the instruments of credit, and a re¬ 
version of principal at maturity, if a bond with a nominal 
return of, say, 5% has been acquired at a price to produce 
4%, and another bond with a nominal return of 4% has 
been acquired at a price to produce 5%, it is plain that in the 
first instance the cash interest income received on the par 
reversion value has been greater than the expected income 


INVESTMENTS 


273 


on the outlay, while in the second instance it has been 
smaller. Submitting these facts to rigid analysis, we see 
that the excess of cash income produced by bonds acquired 
at a premium, represents in reality a periodical return of 
cost over par, that is to say, a reduction of cost, and that the 
excess of effective income produced by bonds acquired at a 
discount represents in reality a periodical accretion of cost 
to par. 

Proceeding further, if 5% on par has been received in 
cash as interest on a bond acquired at a price which would 
produce 4% on cost, the income on the investment will not 
be accurately stated until the earning account to which the 
cash return has been credited, is relieved of the difference. 
And if 3% on par has been received in cash as interest on 
a bond acquired at a price which would produce 4% on 
cost, the income on the investment will not be accurately 
stated until the earning account to which the cash return 
has been credited is increased by the difference. 

What that difference will be found to be in either case, 
depends upon whether we are satisfied with near-accuracy, 
or only with absolute accuracy. In the first instance, it will 
be sufficient to divide the total premium or the discount into 
as many equal units as there are interest periods during the 
remainder of the life of the bonds. In the second instance 
we shall have to compute the exact income on the book 
value of the investment as it stood at the beginning of each 
successive period, deduct that amount from the interest re¬ 
ceived, and apply the difference as a reduction from, or as an 
addition to, the cost. 

The following examples will serve to illustrate the dif¬ 
ferent results obtained under the two methods of treatment. 
In Example A the premium has been amortized in equal 
amounts during the life of the bonds, extending from the 
date on which they were purchased to the date of their 
maturity. 


274 


THE THEORY OF THE ASSET ACCOUNTS 


Example A 
Investment 


5% Bonds of the Millstone Co., payable May i, 1914. Interest pay¬ 
able May and November 1. Acquired to produce 4%. Par, $50,000.00. 


Date 

Interest on Investment 

Principal 

Remarks 

Nominal 

Return 

Period¬ 

ical 

Amor¬ 

tization 

Income 

Dr. 

Cr. 

Balance 

May 1, 1909 
Nov. 1, 1909 
May i } 1910 
Nov. 1, 1910 
May 1, 1911 
Nov. 1, 1911 
May 1, 1912 
Nov. 1, 1912 
May 1, 1913 
Nov. 1, 1913 
May 1, 1914 




$52,245.64 



Cash 

Interest 

tt 

a 

tt 

a 

a 

a 

a 

a 

a 

Cash 

$1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

$224.57 

224.56 

224.57 

224.56 

224.56 

224.57 

224.56 

224.56 

224.57 
224.56 

$1,025.43 

1,025.44 

1,025.43 

1,025.44 

1,025.44 

1,025.43 

1,025.44 

1,025.44 

1,025.43 

1,025.44 

$224.57 

224.56 

224.57 

224.56 

224.56 

224.57 

224.56 

224.56 

224.57 

224.56 

50,000.00 

$52,021.07 

51,796.51 

5i,57i-94 

5i,347-38 

51,122.82 

50,888.25 

50,673.69 

50,449.13 

50,224.56 

50,000.00 






$12,500.00 

$2,245.64 

$10,254.36 

$52,245.64 

$52,245.64 


In Example B which follows, the premium has been 
amortized in accordance with the theory of the accountancy 
of investments. 


Example B 
Investment 


5% Bonds of the Millstone Co., payable May 1, 1914. Interest pay¬ 
able May and November I. Acquired to produce 4%. Par, $50,000.00. 


Date 

Interest 

Principal 

Remarks 

Nomina] 

5% 

on Par 

1 

Effective 

4% 

on Cost 

Amor¬ 
tization 
of Cost 
to Par 

Dr. 

Cr. 

Balance 

May 1, 1909 
Nov. 1, 1909 
May 1, 1910 
Nov. 1, 1910 
May 1, 1911 
Nov. 1, 1911 
May 1, 1912 
Nov. 1, 1912 
May 1, 1913 
Nov. 1, 1913 
May 1, 19x4 




$52,245.64 



Cash 

Interest 

it 

a 

ft 

ft 

a 

tt 

tt 

tt 

tt 

Cash 

$1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

1,250.00 

$1,044.91 

1,040.81 

1,036.63 

1,032.36 

1,028.01 

1,023.57 

1,019.04 

1,014.41 

1,009.71 

1,004.91 

$205.09 

209.19 

213-37 

217.64 

221.99 

226.43 

230.96 

235-59 

240.29 

245.09 

$205.09 

209.19 

213-37 

217.64 

221.99 

226.43 

230.96 

235-59 

240.29 

245.09 

50,000.00 

$52,040.55 

51,831.36 

51,617.99 

51.400.35 

51.178.36 
50,951-93 
50,720.97 
50,485.38 
50,245.09 
50,000.00 

$12,500.00 

$10,254.36 

$2,245.64 

$52,245.64 

$52,245.64 
































































































INVESTMENTS 


275 


When the figures given in Example B are analyzed 
carefully, it is seen that the periodical amortization result 
represents a uniform amount of $205.09 (which is the dif¬ 
ference between the nominal cash interest received, and 
the effective amount expected as income) set aside at every 
interest date, together with interest at 2% semiannually 
(4% annually) earned by the amounts previously set aside, 
and deducted from the cost of the investment at the end 
of the period. 

Hence, the theory of amortization of premiums on 
bonds bearing interest semiannually, rests upon the 
assumption that the amount of cash representing the 
difference between the nominal and the effective rate at 
the time of the first receipt of interest, is deposited twice 
a year at compound interest, in order that at maturity of 
the investment a fund equal to the premium may be 
obtained. 

To prove whether or not this is true, let us assume 
that, instead of periodically reducing the cost of the bonds, 
we allow the original cost to remain undisturbed until 
maturity, and that we deposit twice a year in a special 
fund earning compound interest at 2% semiannually, the 
amount of cash received for interest on the par value in 
excess of the expected income. We then obtain the table 
given on the following page, which reflects faithfully the 
entries made in the ledger accounts which will be affected 
by the transactions. 

The illustration given is all the more interesting be¬ 
cause it shows that the net result of the cash transactions 
incident to the purchase, the interest earnings, and the 
sale of the investment from May 1, 1909, to May 1, 1914, 
has been to increase the wealth of the investor, as repre¬ 
sented by cash, in the amount of $10,449.10, which is 
precisely the amount which he expected his investment 
to produce in five years. 


Example C 


2^6 THE THEORY OF THE ASSET ACCOUNTS 



449 




















































































































INVESTMENTS 


277 

On the other hand, an analysis of the cost transactions 
reflected by Examples “A” and “B,” that is to say, the 
“nearly accurate” and the “absolutely accurate” methods, 
shows: 

Cash Disbursements: 

May 1, 1909 

Paid for investment in 

bonds . $52,245-64 

Cash Receipts: 

Nov. 1, 1909, to May 1, 1914 

Received for interest. $12,500.00 

May 1, 1914 

Received—P a r value of 
bonds.. 50,000.00 62,500.00 

Net increase of cash as a 
result of the investment, 
as corroborated by the 
income accounts from 
Nov. 1, 1909, to May 1, 

I9H . $10,254.36 

So far as cash is concerned, the difference between the 
two sets of results, is nothing more than the interest 
earned by the premium redemption fund created under 
Example C, i.e., $194.74. As to the difference in the 
income, it is due to the fact that, in Example B, the in¬ 
terest supposedly earned by the amount of $205.09 is 
deducted from an asset, while in Example C it is added 
to an asset. Principles of accounting state that if an asset 
is deducted from another, the income which originates 
from the asset thus deducted, is compensated by the de¬ 
crease of the other asset, while, if the asset arising from 
the receipt of income is recorded, the income must also 
be shown. 








2^8 THE theory of the asset accounts 

We will use the same examples in connection with dis¬ 
counts. 

In Example D the discount has been accumulated in 
equal amounts during the life of the bonds. 

Example D 


3% Bonds of the Millstone Co., payable May I, 1914. Interest pay¬ 
able May and November 1. Acquired to produce 4%. Par, $50,000.00. 




Interest 



Principal 



Date 

Nominal 

Rate 

Cash 

Receipts 

Applied 
to Reduce 
Dis¬ 
counts 

Total 

Income 

Dr. 

Cr. 

Balance 

Remarks 

May 1, 1909 

••••••••• 

• ••*••••• 

••••••••• 

$ 47 , 754-36 



Cash 

Nov. 1, 1909 

$750.00 

$224.57 

$ 974-57 

224.57 


$ 47 , 978.93 

Interest 

May 1, 1910 

750.00 

224.56 

974-56 

224.56 


48,203.49 


Nov. 1, 1910 

750.00 

224.57 

974-57 

224.57 


48,428.06 


May 1, 1911 

750.00 

224.56 

974-56 

224.56 


48,652.62 


Nov. 1, 1911 

750.00 

224.56 

974-56 

224.56 


48,877-18 


May 1, 1912 

750.00 

224.57 

974-57 

224.57 


49,101.75 


Nov. 1, 1912 

750.00 

224.56 

974-56 

224.56 


49,326.31 


May 1, 1913 

750.00 

224.56 

974-56 

224.56 


49 , 550.87 


Nov. 1, 1913 

750.00 

224.57 

974-57 

224.57 


49 , 775-44 


May 1, 1914 

750.00 

224.56 

974-56 

224.56 

$50,000.00 

50,000.00 

Cash 


$7,500.00 

$2,245.64 

$ 9 , 745.64 

$50,000.00 

$50,000.00 




The phase of the theory of accounts known as “accoun¬ 
tancy of investments” is much more readily understood by 
the student when applied to premiums than when applied 
to discounts. And yet, the accounting principle is the same 
and is equally plain from either point of view. On the one 
hand, the periodical recovery, under the outward appearance 
of “income,” of the portion of the “cost” of the asset “in¬ 
vestments” which exceeds “par,” necessitates the periodical 
reduction of the asset and of the income. On the other 
hand, the periodically increasing value of the asset in its 
evolution from “cost” to “par,” can only be expressed by a 
corresponding increase of income. 

In Example E the discounts have been accumulated 
scientifically. 













































INVESTMENTS 


279 


Example E 

Z 7 o Bonds of the Millstone Co., payable May 1, 1914. Interest pay¬ 
able May and November 1. Acquired to produce 4%. Par, $50,000.00. 


Date 

Interest 

Principal 

Remarks 

Nominal 

3% 

on Par 

Effective 

4% 

on Cost 

Accum¬ 
ulation 
to Par 

Dr. 

Cr. 

Balance 

May 1, 1909 








Nov. 1, 1909 

$750.00 

$ 955-09 

$205.09 

205.09 


$ 47 , 959-45 

Interest 

May 1, 1910 

750.00 

959-19 

209.19 

209.19 


48,168.64 

«< 

Nov. 1, 1910 

750.00 

963.37 

213.37 

213-37 


48,382.01 

it 

May 1, 1911 

750.00 

967.64 

217.64 

217.64 


48,599-65 

it 

Nov. 1, 1911 

75o.oo 

971.99 

221.99 

221.99 


48,821.64 

it 

May 1, 1912 

750.00 

976.43 

226.43 

226.43 


49,048.07 

if 

Nov. 1, 1912 

750.00 

980.96 

230.96 

230.96 


49 , 2 / 9-03 

ft 

May 1, 1913 

750.00 

985-59 

235-59 

235-59 


49,514.62 

it 

Nov. 1, 1913 

750.00 

990.29 

240.29 

240.29 


49 , 754-91 


May 1, 1914 

750.00 

995.09 

245.09 

245.09 

$50,000.00 


Cash 


$7,500.00 

$9,745.64 

$2,245.64 

$50,000.00 

$50,000.00 




Enough has been said on the subject of premiums and 
discounts to show that the differences developed by the 
sundry methods of treating discounts and premiums are 
not very important, in so far at least as small investors 
are concerned. 

As to large investors, it would seem that their policy 
being to invest in such a manner as to obtain a stated 
rate of income, nothing will satisfy their requirements 
but the method which will make the income account re¬ 
flect the effective (or expected) rate of income which they 
receive. 

Courts of law are not unlikely to frown at scientific 
methods of amortizing or accumulating bonds to par in 
connection with the interests of life-tenants and re¬ 
maindermen. The following quotation from the Cyclo¬ 
paedia of Law and Procedure will point out how divergent 
opinions are in respect to premiums and discounts: 

“It is very generally held that if a testator leaves 
bonds which he owns to trustees, with direction or 

















































280 THE THEORY OF THE ASSET ACCOUNTS 


authority to hold the same, paying the interest to certain 
persons for life, with remainder over, the fact that such 
bonds are worth a premium at and after his death, will 
not warrant the trustees in retaining any portion of the 
interest for the benefit of the remaindermen. 1 But in 
the case of bonds purchased at a premium by the trustees 
after the testator’s death, the cases are in hopeless conflict. 
In some states it is held that such premiums are to be charged 
to principal, and not to income, and a trustee is not justified 
in withholding a part of the income to meet a diminution of 
principal which may not ever take place. 2 In other states 
the rule is laid down that where trust funds are invested in 
bonds running for a term of years and purchased at a 
premium, in the absence of a clear direction in the will to 
the contrary, such a proportionate deduction should be made 
from the nominal interest as will, at the maturity of the 
bonds, make good the premium paid, and preserve the 
principal of the fund intact at maturity. This is called the 
sinking fund rule. 3 ” 


Investment Accounting 

A great deal has been said about the difficulty of the 
theory of the accountancy of investments. Still, if the 
principle is understood, nothing is simpler than to 
amortize bonds when the cost, the nominal rate on par, 
the effective rate on cost, the interest periods, and the 
life of the securities are known. 


1 Connecticut Trust, etc., Co.’s Appeal, 80 Conn. 540; 69 Atl. 360; Show v. 
Cordis, 143 Mass. 443; 9 N. E. 794; Hemenway v . Hemenway, 134 Mass. 446; etc. 

2 Hite v . Hite, 193 Ky. 257; 20 S. W. 778; 14 Ky. L. Rep. 385; 40 Am. St. Rep. 
189; 19 L. R. A. 173; In re Penn Gaskell, 208 Pa. St. Super. Ct. 526, holding 
further that a direction in a will that “the net income of certain funds is to be 
paid to the life-tenant,” does not permit any deduction from such income to pro¬ 
vide for the possibility of loss by the principal on account of premiums paid for 
investments; In re Furney, 12 Phila. Pa. 130. 

3 Connecticut—Curtis v . Osborn, 79 Conn. 555; 65 Atl. 968; Massachusetts- 
New England Trust Co. v . Eaton, 140 Mass. 532; 4 N. E. 69; 54 Am Rep 493- 
New Jersey—Ballantine v . Young, 74, N. J. Eq. 572; 70 Atl. 668; New York —In re 
Stevens, 187 N. Y. 471; 80 N. E. 358 (modifying in N. Y. App. D. 773; 98 N. Y. 
Suppl. 28); etc.; other cases quoted. But see matter of N. Y. L. Ins., etc., Co., 24 
Misc. 71, holding that the loss or gain in the value of securities purchased by a 
trustee, in the exercise of his sound discretion, should go to the diminution or 
accretion, as the case may be, of the capital, and not of the income, unless a 
contrary intention must be implied from the trust instrument. 




INVESTMENTS 


281 

As to accounting problems based on this subject, 
which C. P. A. candidates are asked to solve at examina¬ 
tions, they uniformly state the par value of the bonds 
acquired, the nominal rate, the effective rate, the interest 
periods, and the life of the bonds, and require the finding 
of the cost. No candidate should fail to meet the test if 
he really understands the theory of amortization. He re¬ 
quires no algebraic formulae, and no more advanced 
knowledge of mathematics than familiarity with division, 
subtraction, and addition. 

Considering the meaning of the transactions which 
will take place at the maturity of the securities, he will 
see at once that there will be received by the investor: 

1. The par value of his investment. 

2. The last instalment of the premium annuity re¬ 

payable in as many periods as the bonds have to 
live between the date of the purchase and that 
of the maturity. 

3. The effective (or expected) rate on cost. 

Items 2 and 3 are included in the receipt of the 
nominal rate on par receivable at the same time as the 
principal. 

Adding the proceeds of principal at the end of the last 
period, to the proceeds of interest received at maturity, 
at the nominal rate, a sum is obtained which is composed 
of the whole cost (i.e., 100%) at the beginning of the 
said last period, plus the effective interest on cost. 

Dividing the sum of the cost of the principal at the 
end of a period, inflated by the nominal interest return, 
by 100, plus the effective interest rate for the period, will 
give the cost at the beginning of the prior period. 

Example: One hundred bonds of the M. K. T. Co. 
were acquired on January 1, 1913; they are due June 30, 
1914, and bear interest at 5%, January and July. They 
were acquired to produce 3%. Required, cost of bonds. 


282 THE theory of the asset accounts 


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INVESTMENTS 


283 

It will be noticed that the example shows the periods 
in their reverse order. 

Besides the methods suggested above for recording 
the investment in bonds in accordance with the very 
purpose of the investment, there is another which is 
adopted by all concerns which wish to make their invest¬ 
ments reflect market values. It is as follows: 

As to Principal. Having stated the investments at 
cost, adjust them to the market value at the end of every 
period, debiting or crediting the difference to profit and 
loss. No premiums or discounts are considered. 

As to Income. Take it at the nominal rate of the 
bonds, and make no adjustment whatever. 

It may be said of the foregoing that while this method 
is not objectionable in the case of speculative investments, 
it should be obnoxious to the very purpose of permanent 
investments, since they are made for income, and not for 
speculative profit. 

The question of discounts and premiums suffered or 
received by corporations through the issue of certificates 
of indebtedness will be taken up in subsequent chapters. 

4. Investments in Stocks of Other Companies 

Whether the reason for making the investment has 
been to obtain income, to control competing interests, or 
otherwise, permanent investments in stocks of other com¬ 
panies should be carried at cost. 

In so far at least as the investor is concerned, the 
question of discounts and premiums never arises in con¬ 
nection with capital stock. A certificate of stock conveys 
no promise, expressed or implied, that a certain sum of 
money will be paid to the holder at any time. Generally 
speaking, whatever is received on account of stocks is 
income, and is commonly referred to as “dividends on 



284 THE THEORY of the asset accounts 

stocks.” It must be said, however, that dividends re¬ 
ceived on the stock of mining companies which do not set 
aside a certain proportion of their earnings to take care 
of the exhaustion of ore-bearing veins concurrently with 
operations, carry a certain return of the original invest¬ 
ment. It is seldom possible to estimate what that amount 
is, as it is not a positive and well-known quantity, like the 
difference between par and cost as in the case of bonds, 
but depends not only upon the accuracy of the estimate 
of ore which the veins will produce, but also upon the 
value of the other assets of the company when operations 
cease because this ore is exhausted. Hence, it is very 
difficult to set aside out of dividends, an amount which 
will truly offset, at the winding up of the company, the 
amount originally invested. The same thing is true of 
land improvement companies, and of similar enterprises 
where the capital assets waste concurrently with the 
progress of the business. 

The temptation to adjust the book value of invest¬ 
ments to their market value is admittedly greater in 
connection with stocks than with bonds, because the 
fluctuations of stocks are greater and more frequent than is 
the case with bonds. Still, the principles which apply to 
one class of securities apply also to the other. It is quite 
evident that before the New York State Insurance De¬ 
partment restricted the investments in stocks which life 
insurance companies were in the habit of making, unfavor¬ 
able conditions in the securities market at the end of a 
fiscal period would have had a considerable effect upon 
the dividends to policyholders paid by a company whose 
custom it was to adjust its investments periodically upon 
the basis of market values. Assuming that at the end of 
the year 1912 a “paper loss” of $20,000,000 had been 
sustained owing to panicky conditions, and that one year 
later a “paper gain” of an equal amount had been realized, 


INVESTMENTS 


285 

due to an unusually optimistic feeling prevalent in Wall 
Street, the financial status of the company at December 
31, 1912, would not have depressed the directors of the 
company any more than the financial status at December 
31, 1913, would have elated them. Their investments 
being made supposedly with a view to permanency, the 
fact that the value of their securities was boosted by 
“bulls” or dragged down by “bears” would not have 
affected them in the least, for in neither case was there 
any necessity of selling the investments. As a matter of 
fact, however high the value of the securities might have 
soared, the sudden appearance on the market of a con¬ 
siderable block of stocks offered for sale by life insurance 
companies would very probably have had the immediate 
effect of lowering prices. 

But leaving aside the natural indifference of the com¬ 
pany to “paper losses” and “paper gains” on market 
values, let us consider the case of two holders of “tontine” 
policies of equal amount, maturing, one at December 31, 
1912, and the other at December 31, 1913. It is quite 
obvious that the year 1912 having sustained a supposed 
loss of $20,000,000, the dividends received by the holder 
of the policy maturing in that year would have been dis¬ 
proportionate to those received in the subsequent year by 
a similar policy whose good fortune it was to mature at 
a time when the “bulls” were the masters of the situation 
in Wall Street. 

5. Investments in Real Estate 

In connection with investments in real estate, whether 
made by direct purchase, or as a result of the foreclosure 
of investments in bonds and mortgages, there arises the 
question of incumbrances. 

Incumbrances have been thus defined: “An interest 
in, or chargeable on, land, which may subsist in, or in 


286 THE THEORY of the asset accounts 

favor of, a third person, consistently with a transfer of 
the fee, but diminishes the value of the estate of the 
occupant.” 

Incumbrances include: mortgages and the interest 
thereon (as well as the claims of the mortgagee for taxes, 
assessments, and fire insurance); assessments, taxes, 
mechanics’ liens, landlords’ liens, attachments, judgments, 
visible easements, pending suits, etc. Some of these liens, 
to be binding on third parties, must be duly recorded in 
accordance with statutory provisions, or be otherwise 
known to exist; others may be readily ascertained 
through the exercise of proper diligence and care. In no 
case is the purchaser of incumbered property permitted to 
plead ignorance. He must examine records or recorded 
liens, and must inquire in regard to the existence of other 
incumbrances. 

Generally speaking, the purchaser of real property 
takes only such title as the vendor had. It must be 
added, however, that a purchaser is supposed to be en¬ 
titled to a good title, free of incumbrances, and that, if 
any incumbrances are existing, it is the duty of the vendor 
to remove them. Nevertheless, the covenants of the deed 
of sale will, in the absence of fraud on the part of the 
vendor, be accepted as regulating the rights and the 
liabilities of the parties. Thus, if property acquired is 
subject to incumbrances, the purchaser either agrees to 
take it subject to these liens, which the vendor must 
satisfy, or he specifically agrees to assume all liabilities for 
liens. In the first instance he will pay the value of the 
property as if it were unincumbered; in the second in¬ 
stance he will deduct from the purchase money the 
amount necessary to liquidate the liability for existing 
liens. 

In regard to taxes and assessments, the general rule 
is that, whenever the vendor agrees to liquidate, or to 


INVESTMENTS 


287 


provide for, the liabilities, no lien whatever attaches to 
the vendee for taxes and assessments which are liens at 
the time of the contract. As to whether or not accrued 
taxes and assessments the extent of which is not positively 
ascertained, are liens at the time of the sale, depends 
largely upon the statutes of the individual states. There 
are some states, for instance, where the law provides that 
persons who are the owners of real property at a certain 
date of the year, will be liable for the taxes of that year. 
In a Mississippi case, it was held that where the vendor 
agreed to liquidate, or provide for, all liabilities, he was 
liable for taxes fixed by statute as due on a date prior to 
the contract, even though the extent thereof was not 
ascertained for several months thereafter.* In the state 
of New York, it has been held and affirmed that if the 
vendor covenants to convey property free of all incum¬ 
brances, taxes, and assessments, the extent of which is 
determined in the manner prescribed by law only after 
the conveyance, are liabilities of the vendee, and not of 
the vendor.! 

In regard to all other incumbrances, it may be said 
that unless purchasers of real estate expressly bind them¬ 
selves in the deed of sale, they are not liable to creditors 
of the vendor. 

Accounting for Real Estate Investments 

So far as accounting is concerned, property acquired 
subject to existing liens which are not the purchaser’s 
liability, is recorded by merely stating what it cost; if 
liabilities are assumed by the purchaser, the property is 
recorded at its purchase value, credit being given to cash 
for the amount paid, and to the liabilities for the amount 

* Vicksburg Waterworks Co. v. Vicksburg Water Supply Co., 80 Miss. 31, 
68, 80. 

t Lathers v. Keog, 109 N. Y. 583; 17 N. E. 131; affirming 39 Hun 576. 



288 THE THEORY of the asset accounts 


assumed by the purchaser in taking- over the property; for 
example: 

1. Investment in Real Estate. .$20,000.00 

To Cash. $20,000.00 

For acquisition of a parcel 
of property located at 
. as de¬ 
scribed in a deed of sale, 
reference to which is 
hereby made. The prop¬ 
erty was subject, at the 
time of the transfer of 
the fee, to a mortgage of 
$10,000 which the vendor 
has agreed to satisfy at 
maturity out of the pro¬ 
ceeds of the sale. 

2. Investment in Real Estate. .$20,000.00 

To Cash.. 

“ First Mortgage Pay¬ 
able . 

For acquisition of. 

The property is incum¬ 
bered by a first mortgage 
(describe) which has been 
assumed by the pur¬ 
chaser. 

Whether purchased property is incumbered or not at 
the time of acquisition, the purchaser may incumber it by 
giving to the vendor a “purchase money mortgage” 
covering part of the purchase price. Under these con¬ 
ditions, the foregoing illustrations might read: 


$10,000.00 

10,000.00 







INVESTMENTS 


289 


1. Investment in Real Estate. .$20,000.00 

To Cash. $12,000.00 

“ Purchase Money 
Mortgage Pay¬ 
able . 8,000.00 

2. Investment in Real Estate. .$20,000.00 

To Cash. $ 4,000.00 

First Mortgage 

Payable. 10,000.00 

Purchase Money 

Mortgage Payable 6,000.00 


The components of the book value of investments in 
real estate may be: 

1. The cost of the property, including: 

a. If the property has been acquired in the real 

estate market, the cost of acquiring title, 
whatever the amount may be in particular 
cases, as well as commissions and brokerage 
incident to the purchase. 

b. If the property has been acquired as a result 

of foreclosure, the cost of all advances 
made for the account of the mortgagor by 
the concern in its capacity as mortgagee, 
such as amounts expended for taxes, for 
insurance premiums, and for repairs and 
improvements prior to acquisition of the 
property upon default of the mortgagor. 

2. The cost of such improvements as enhance the 

marketable value of the buildings, or make them 
more desirable to tenants, or increase the rate 
of rentals. 

If the policy of the concern is to carry its investments 
at market value, the fluctuations of the market are re- 






290 


THE THEORY OF THE ASSET ACCOUNTS 



Figure 40. Investment Ledger 




















































































































INVESTMENTS 


291 


corded periodically by means of debits or credits to the 
asset account, and corresponding credits and debits to the 
Profit and Loss account. 

If the amounts involved are considerable and a great 
many separate parcels of property are carried, a special 
ledger may be assigned to the detail of the asset account. 
This book may be made very thorough by means of 
sections which will record the original value and the 
fluctuations of the investment, the original incumbrances 
attaching to the property, and the gradual extinguish¬ 
ment thereof, and the total of the positive and negative 
factors affecting the income received on the investment. 
The foregoing form is adaptable to the requirements of 
large investors. 


CHAPTER XXIV 


SPECIFIC FUNDS, RESERVE FUNDS, AND 
FUNDED RESERVES 


Specific Funds 

In the course of business, it frequently becomes advis¬ 
able to set aside specific funds, in order that certain pur¬ 
poses may be fulfilled, or certain policies carried out. 
Thus, a social club may periodically set aside part of its 
receipts for the purpose of erecting a permanent home for 
the association; a life insurance company may set aside 
and intrust to influential persons, funds which are to be 
used to defeat proposed legislation which it considers 
fatal to principles of life insurance; a large concern may 
place considerable sums in the hands of its officers to be 
used for the benefit of the business at large and accounted 
for periodically. 

These specific funds, whether known as building, 
emergency, legislative, working, or experimental funds, 
or otherwise, need have no connection whatever with 
profits. They are, in reality, part of the available cash of 
the concern, whether that cash comes from operative re¬ 
sults or from capital contributions. Unless protected by 
resolutions of the directorate, they can be used for pur¬ 
poses other than that for which they were originally cre¬ 
ated, and whenever the amount provided is greater than 
the requirements, or the policy which caused their crea¬ 
tion is abandoned, the balance reverts to the general cash. 
They are current assets and are stated as such on the 
balance sheet. 


292 


SPECIFIC FUNDS AND RESERVES 


293 


Reserve Funds 

In contradistinction, reserve funds are accumulated 
out of realized profits; that is to say, they are brought 
into existence by being separated from the fund of liquid 
assets which have come in as a direct result of profitable 
operations. They are created for the express purpose of 
liquidating liabilities incurred in order that the earning 
power of the concern may be maintained or increased, or 
to replace physical assets when they have outlived their 
usefulness. They apply the principle of finance that capi¬ 
tal borrowed to obtain income should be paid out of the 
income which it makes possible, or that assets which have 
been consumed by operations must be replaced out of 
profits. They can be applied only to the purpose for 
which they were created, and if they ever revert to the 
general cash it can only be because they were larger than 
necessary. Their ultimate disposition is so well estab¬ 
lished that they cannot be considered as current, or liquid 
assets; the Interstate Commerce Commission includes 
them among deferred debit items, that is to say, it treats 
them as factors which can only fulfil their mission by be¬ 
ing debited to the particular liability which they are in¬ 
tended to extinguish, or to the particular asset the value 
of which they will eventually measure. 

Funded Reserves 

If corporations borrow capital in order that they may 
obtain therewith an income greater than the cost of bor¬ 
rowing, and if prudence requires that part of the excess 
income thus obtained be applied to the liquidation of the 
debt, there are two distinct ways of arriving at the re¬ 
quired result: 

1. Set aside periodically a proportion of the profits 
which have been realized, in cash, thereby cre¬ 
ating reserve funds. As indicated above, this is 


294 THE THEORY of the asset accounts 

done by crediting cash, and debiting a fund so 
earmarked as to indicate the purpose of the 
special deposit; the cash reserved is usually in¬ 
vested in some manner deemed suitable or ad¬ 
vantageous, i.e., it may be left in a deposit account 
with a bank, or it may be exchanged for interest- 
bearing securities. 

2 . Set aside periodically a proportion of the net 
profits, by debiting “Profit and Loss”—the 
summary account which measures them—or 
“Surplus”—the other summary account which 
contains them—and crediting properly ear¬ 
marked “reserves” which will measure the 
aggregate amount of surplus appropriated for 
special purposes. 

It will be noticed that either method accomplishes its 
purpose properly; the reserve prevents the distribution of 
the reserved cash profits otherwise than for the liquida¬ 
tion of certain obligations; the fund is just as effective, 
since it sets aside and earmarks as reserved for special 
purposes, part of the cash obtained through profits. 

If a reserve has been created, and, in addition to this, 
cash is set aside in a special fund, it is only because of 
scrupulous conservatism. This operation, which is re¬ 
ferred to as “funding reserves,” has been criticized as 
often as the wisdom of creating reserve funds has been 
challenged. Railroad economists claim that to invest the 
large amounts necessary to liquidate the bonded indebted¬ 
ness of common carriers, at a rate of interest infinitely 
inferior to the earnings which that money could secure it 
used for the requirements of the road, is equivalent to mis¬ 
management. They further assert that the greatest 
security which railroad bondholders can have is the pros¬ 
perity of the enterprise, and that anything that detracts 



SPECIFIC FUNDS AND RESERVES 


295 


from that prosperity is detrimental to their interests; that 
since reserve funds, by withdrawing cash from operation, 
reduce the income of railroads, they should not be 
created, the reserve alone being sufficient. 

It sometimes happens, however, that bond indentures 
compel the periodical payment to a trustee of certain 
sums which will accumulate at interest until sufficient to 
liquidate certain debts. When this is the case, nothing 
but the reserve fund will satisfy the bondholders, and the 
usefulness of a reserve carried in conjunction with the 
fund is more than problematic. 

The meaning of the term “reserve fund” as given in 
the foregoing, is far from being generally accepted. 
Many writers of accounting hold that there is no differ¬ 
ence whatever between “reserve funds” and “reserves,” 
and that both are amounts set aside out of profits, to be 
used, if the occasion requires, to write down the book 
value of the assets to which they apply. 

It is true, of course, that a reserve for depreciation of 
machinery will be applied to the undepreciated book 
value of the assets when the machinery has outlived its 
usefulness; but that reserve is not a fund, although it 
could be funded. It is also evident that a reserve for 
redemption of bonded indebtedness could never be ap¬ 
plied to the reduction of any asset whatever, and that it 
is not a fund at all, although it is supposed to be repre¬ 
sented by funds which are not specifically invested. The 
Interstate Commerce Commission appears to have settled 
the controversy; it requires that reserves created out of 
income or surplus be shown as follows, on the balance 
sheet of common carriers: 

1. Invested in Sinking and Redemption Funds 

2. Invested in Other Reserve Funds 

3. Not Specifically Invested 


296 the theory of the asset accounts 

Sinking Funds 

The most common of all the “reserve funds” is the 
“sinking fund for the redemption of bonds.” These sink¬ 
ing funds may be created in several ways: 

1. Taking as a basis the life of the debt to be liqui¬ 

dated, deposit periodically amounts equivalent 
to 1/5, or 1/10, or 1/20 of the original amount 
due, less whatever interest the fund as it stands 
has earned during the prior period, it being 
understood that the last deposit produces no 
interest. 

2. Divide the amount of the debt to be liquidated, by 

the amount of the annuity of $1 for the given 
term of the debt, at a given rate. The quo¬ 
tient will be the amount of dollars of each suc¬ 
cessive sinking fund instalment. 

The examples A and B show that the interest earned 
by the sinking fund is debited to the fund itself, and 
credited to the earning account “Interest on Sinking 
Fund.” It has been claimed that it should be credited 
to the account which is debited with the interest paid on 
the bonds. The intrinsic worth of such a theory is to be 
appraised in the light of principles of finance. The in¬ 
terest earned by a fund created by setting aside assets 
obtained out of the reinvestment of profits made possible 
by the incurrence of long-term liabilities, is hardly a de¬ 
duction from the cost of carrying that liability. 

So far as their accounting treatment is concerned, re¬ 
demption funds are similar in every respect to sinking 
funds. The difference in terminology merely means that 
sinking funds are supposed to be created in compliance 
with what is known as the “sinking fund provision” of 
bond indentures, whereas redemption funds are created 
to retire any long-term liability which is not subject to 
sinking fund requirements. 


Sinking Fund Invested at 4 % 

$50,000 of bonds issued January, 1, 1909, maturing January i, 1914, bearing interest at 5% semiannually Jan¬ 
uary 1 and July 1. 


SPECIFIC FUNDS AND RESERVES 


297 


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298 THE theory of the asset accounts 


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CHAPTER XXV 


ACCRUED INCOME NOT DUE 
Income from Investments 

The income from: (i) investments in real estate, (2) 
bonds of other companies, loans on collateral (call or 
time), bonds and mortgages, and (3) stocks of other 
companies, is, in the order given: rent, interest, and 
dividends. 

Since the date at which rents and interest mature 
does not always coincide with the last day of the ac¬ 
counting period, it follows that an amount of income on 
investments may have been earned which does not 
appear on the books, because cash has not been received 
therefor. 

The Cash Basis 

It may be that the policy of a concern is to keep its 
books on the “cash basis,” that is to say, to consider as 
income earned only that which has been received in cash, 
and that, correspondingly, only expenses paid in cash con¬ 
stitute income disbursed. This policy has the great 
disadvantage of not being consistent. It rests upon the 
possibility that the right to receive income may be lost 
by the failure of the debtor to pay what he owes, and 
upon the impossibility of enforcing payment when such 
contingency occurs. But if the basis is correct, it should 
apply also to accounts receivable recorded as a result of 

299 


^oo THE THEORY OF THE ASSET ACCOUNTS 

sales on credit, since the amount charged to customers 
contains not only the cost of the goods sold to them, but, 
as well, the profit realized on the sales. It is obvious that 
if it is sound theory to ignore income until it is received, 
it is also sound theory to ignore the profit on sales until 
the customers have paid the indebtedness which contains 
those profits. Yet it is doubtful whether a single instance 
could be found where a business concern which claims to 
be on a cash basis is consistent enough to apply that 
basis to merchandise transactions. 

The Accrual Basis 

Many concerns keep their books on the “accrual 
basis.” This method applies the accounting principle that 
the primary connection between the net assets and the 
net income derived therefrom, is a matter of earnings and 
of expense incurred, and not one of income received in 
cash and expenses paid in cash. It takes cognizance of 
the fact that unless income is recorded when earned, 
losses due to the failure to collect that income cannot 
appear on financial statements. 

It might be supposed that an accountant had earned, 
during a calendar year, say, $10,000, and had been un¬ 
able to collect more than half of that sum, the balance 
being bad debts. If his books were kept strictly on the 
cash basis his earning capacity would be shown to have 
been $5,000 during that year, and no loss would appear 
in his income account. If his books were kept on the 
accrual basis, that capacity would be shown to have been 
$10,000, and his financial statements would show the fact 
that, being unable to collect more than half of that sum, 
he had sustained a loss of $5,000, owing to the financial 
' incapacity of his clients or their bad faith. 

Leaving expenses and liabilities out of the question 
for the time being, the adoption of the accrual basis 


ACCRUED INCOME NOT DUE 


301 


means that at the end of every accounting period, all in¬ 
come which has been earned during that period must be 
recorded as an accrued asset which, while perhaps not 
collected at the time, because it is not due, may be col¬ 
lected at some future time. This, of course, necessitates 
the recording of an income which will be credited to the 
profit and loss of the period, whether or not the accrued 
asset which it represents fails of collection. Thus, if the 
last interest receivable on investments in bonds of other 
companies or in bonds and mortgages or in loans on 
collateral, was received December 1, and the accounting 
period ends December 31, there has been earned interest 
for one month, which is an asset of the investor as well as 
it is his income for the month of December. 

Nature of Dividends 

Dividends differ materially from rentals and interest; 
they do not belong to the stockholders until they have 
been declared and the knowledge of the resolution of 
the board of directors has become known outside of the 
board room. Hence, it is not possible to take as an 
asset and as income, dividends which are expected on 
investments in stocks of other companies, since there is 
no certainty that the directors will deem it advisable to 
distribute part of the surplus. But if a dividend has been 
declared, its amount must be taken both as an asset and 
as income, even though it be made payable months later. 
The legitimacy of the asset cannot be denied, since, after a 
dividend has been declared, it cannot be rescinded unless it 
has been established that its declaration was illegal. 

Record of Earnings on Investments 

The journal entries giving expression to the earnings 
on investments and to the corresponding accrued assets 
which they represent, are as follows: 


^02 THE THEORY of the asset accounts 

• 

Accrued Rentals—Real Estate.. $. 

Accrued Interest on Bonds of 

Other Companies... 

Accrued Interest on Bonds 

and Mortgages. 

Accrued Interest on Collateral 

Loans . 

Dividends Receivable (de¬ 
clared) ... 

To Rentals on Real Es¬ 
tate . $.- 

“ Interest on Bonds of 

Other Companies ... 

“ Interest on Bonds 

and Mortgages.. . 

“ Interest on Collat¬ 
eral Loans...... 

“ Dividends on Stocks 
o f Other Com¬ 
panies . . 

To set up both the asset 
and the income derived 
from investments. 

Whatever is collected on the asset should be credited 
to the asset account, in order that it may show at any 
time the balance accrued thereunder, and not as yet col¬ 
lected or collectable. The income account should contain 
no credits whatever on account of cash receipts, and the 
debit side of the accrued asset should at all times be 
equal to the credit side of the earning account. This 
means that if an investment is sold or expires during an 
accounting period, the first care of the accountant should 
be to make both the asset account “Accrued Interest ,, 
and the income account “Interest” reflect, in anticipation, 















ACCRUED INCOME NOT DUE 


303 


that part of the proceeds of the sale or of the settlement 
at maturity, which will not represent principal. Unless 
this is done, the books will show that interest income was 
obtained partially through the accrual of an asset and 
partially through the receipt of cash. 

To illustrate: On January 15, 1914, A loaned B, 
against proper collateral, $10,000, at 6%, principal re¬ 
payable on July 15, 1914, interest payable at maturity. 
A closes his books on the last day of every month. 

At July 15, 1914, prior to the settlement made by B, 
A’s books show, on the 360-day basis: 

Investment in Loans on Collateral 

1914 

Jan. 15 Cash. $10,000.00 

Accrued Interest on Loans on Collateral 


1914 
Jan. 30 

Interest on Loans 



on Collateral.. 

$ 25.00 

Feb. 28 

ii 

50.00 

Mar. 31 

ii 

50.00 

Apr. 30 

it 

50.00 

May 31 

a 

50.00 

June 30 

it 

50.00 


$275-00 


Interest on Loans on Collateral 


1914 
Jan. 30 
Feb. 28 
Mar. 31 

Profit & 

ii 

ii 

Loss.. $ 25.00 

5000 

.. 5000 

1914 
Jan. 30 

Accrued Interest 
on Loans on 
Collateral .... 

$ 25.00 

Apr. 30 

ii 

.. 50.00 

Feb. 28 

it 

• • • • 

50.00 

May 31 

it 

.. 50.00 

Mar. 31 

a 

• • • • 

50.00 

June 30 

ii 

50.00 

$275.00 

Apr. 30 
May 31 
June 30 

a 

• • • • 

it 

• • • • 

it 

• • • • 

50.00 

50.00 

50.00 

$27500 



























304 


THE THEORY OF THE ASSET ACCOUNTS 


Now, if upon settlement by B, on July 15, 1914* A 
makes the following entry: 

Cash .$10,300.00 

To Investments in 
Loans on Collat¬ 
eral . $10,000.00 

“ Accrued Interest on 
Loans on Collat¬ 
eral . 275.00 

“ Interest on Loans 

on Collateral.... 25.00 

it is evident that the asset account “Accrued Interest” 

will fail to reflect the whole amount of the earnings to 
which it owes its existence, and that the earning account 
will be composed of two distinct elements: 

1. One, said to be an earning, due to the fact that an 

asset receivable was placed on the books. 

2. The other, said to be income, due to the fact that 

cash came in, in settlement of interest earned. 

Would it not be more logical to carry the theory of ac¬ 
cruals throughout the accounting period, and on the day of 
settlement of the loan make the following journal entries? 

1. Accrued Interest on Loans 

on Collateral.$ 25.00 

To Interest on Loans 

on Collateral. $ 25.00 

For interest accrued to 
date of settlement of 
principal and of inter¬ 
est on loan of $10,000 
secured by collateral, 
maturing this day. 







ACCRUED INCOME NOT DUE 


3°5 


2 - Cash .$10,300.00 

To Loans on Collat¬ 
eral . 10,000.00 

“ Accrued Interest 
on Loans on 

Collateral .. . 300.00 

For settlement of loan 
and collection of assets 
receivable on account 
of interest from Janu¬ 
ary 1, 1914, to July 15, 

1914. 

♦ 

Income from Bonds 

If reference is made to the discussion of investment in 
bonds of other companies,* it will be found that the 
nominal account representing the income derived there¬ 
from, may under certain conditions contain debits and 
credits for amortization and accumulation of cost of in¬ 
vestments to par. It must be said at this point, that even 
where investments are carried at par, and separate 
accounts are kept for discounts and premiums, the nature 
of these latter accounts is such that they should be written 
down by means of periodical credits and debits to the 
nominal account representing interest on investments in 
bonds, and not, as is so often the custom, by credits and 
debits to the Profit and Loss account. 

When the conditions just described prevail, the asset 
account “Accrued Interest on Investments” should con¬ 
tain the nominal rate receivable on the face of the bonds, 
since in case of default the amount claimed by the in¬ 
vestor will be the principal, i.e., par, plus the interest on 
par at the rate stated on the instrument of credit. As to 
the earning account, it should reflect the true income 


* Chapter XXIII. 





306 the theory of the asset accounts 

which the bonds were to produce at the price at which 
they were acquired. This is the only case where the debit 
side of the asset account “Accrued Interest on Invest¬ 
ments” should not duplicate exactly, and, at all times, the 
credit side of the earning account “Interest on Invest¬ 
ments.” 


CHAPTER XXVI 


ACCOUNTS PARTIALLY REAL AND PARTIALLY 
NOMINAL—DEFERRED DEBIT ITEMS 

Allocation of Periodical Expenses 

When a concern has adopted the policy of charging 
against the income of a period, all the expenditures made 
and all the obligations incurred during that period for the 
protection of the physical assets, as well as for the acqui¬ 
sition of minor supplies intended to be consumed through 
the operation of the business as a whole, the question of 
accounts partially real and partially nominal arises only 
in connection with trading or manufacturing goods.* 

The policy referred to above is often qualified as 
“conservative” by those who have adopted it. Usually, 
however, it is objectionable to accountants because, by 
making the profits of certain periods suffer a detriment 
for the benefit of other periods, it destroys utterly the 
value of comparisons. 

When profits are ascertained yearly, it may be said 
with a semblance of truth that the law of averages is likely 
to make all periods very nearly alike, since the same ex¬ 
penses are bound to occur year in and year out, unless 
changes of policy have taken place in the interim. Still, 
this is not always true. Let us assume, for instance, that 
on January 2, 1912, a building was insured against fire, 
the policy covering a period of three years; it is obvious 
that because the year 1912 has been made to bear the 


* Discussed in Chapter XVI. 


307 



308 the theory of the asset accounts 

burden of the whole insurance premium paid during that 
year, the profits will suffer by comparison with the future 
profits of the years 1913 and 1914. And, if in the year 
1913 a large amount of stationery is acquired in order to 
take advantage of the considerable saving which large 
orders afford when type has to be set up, it is evident that 
unless the cost of these supplies is spread over the periods 
in which they are consumed, the year 1913 will sustain a 
burden which the law of averages will not relieve in the 
least. 

It is for this reason that accountants recommend 
that, at the end of every accounting period, a sharp line 
be drawn between the expenses applicable to the period 
which has just expired, and the expenses applicable to 
subsequent periods. 

Common Accounts Partially Real and Partially Nominal 

The individual accounts which may be considered as 
partially real and partially nominal, vary according to the 
particularities of business. The most commonly found are: 

1. Fire Insurance Premiums 

2. Advertising Contracts 

3. Stable Supplies 

4. Stationery and Printing 

5. Advertising Matter 

These accounts are subject to periodical inventories. 
This statement applies even to fire insurance premiums, 
since, to ascertain the amount applicable to subsequent 
periods, it is necessary to marshal the policies, and con¬ 
sider their terms. It is precisely because the values which 
they represent are susceptible of being inventoried, that 
they are to be found stated under the balance sheet group 
“Working and Trading Assets,” together with the in¬ 
ventories of trading goods, manufacturing materials, 
goods in process, and finished goods. 



DEFERRED DEBIT ITEMS 


309 


Fire Insurance Premiums 

The advisability of carrying as an asset the portion 
of the fire insurance premiums which applies to periods 
subsequent to the one at issue, results not only from the 
requirements of proper accounting, but, as well, from the 
very nature of the contract of insurance for which the 
premium paid is the consideration. 

The law provides that whenever an insured party sur¬ 
renders his policy, orders it canceled, and demands the 
refund of the unconsumed proportion of premium paid 
thereunder, his right to the refund shall be absolute, pro¬ 
vided the policy contract contemplates the eventuality of 
cancellation. The amount of premium to be refunded will 
not, however, be the proportion of the whole which 
applies to the unexpired period covered by the original 
contract. It will be the amount of the premium, less what 
the cost of insurance would have been if the policy had 
been issued for the time during which the insurer was in 
the risk.* The insurer may, besides, deduct from the 
amount of the premium to be returned, his ‘‘reasonable” 
expenses in writing the policy. 

Hence, the amount of fire insurance premiums which 
going concerns carry as an asset at the end of an account¬ 
ing period, is never the exact amount which would be 
received if the policy were to be canceled on what is 
called the “short rate” basis. Still, for the purpose of 
statements purporting to show the financial status of such 
concerns, it is evident that the only expense incurred on 
account of fire protection, is the proportion of it which 
applies to the period covered by the statement, since 
there is no intention of surrendering the policy. 

For the purposes of statements purporting to exhibit the 
financial status of a concern facing liquidation through 
financial distress or otherwise, it is better to carry the asset 


* Matter of Independence Insurance Co., 13 Fed. Cas. No. 7015. 



310 THE theory of the asset accounts 

“Fire Insurance Premiums, Unexpired Proportion,” at the 
probable value to be received upon cancellation of the 
policy. What that value will be, is indicated by what is 
known as “Union Short Rate Tables.” 

Advertising Contracts 

When advertising contracts have been paid in ad¬ 
vance, it is customary to apportion their cost over the 
periods during which they run. The word “paid” does 
not necessarily mean paid in cash. If a going concern has 
placed an advertising contract for a year, agreed to pay 
monthly a sum of $100 therefor, and recorded its rights 
and duties under the contract in the following manner: 

Advertising Contract.$1,200.00 

To Creditor’s Account. .. $1,200.00 

it has, so far as accounting is concerned, paid $1,200 in 
advance, since it has recorded a lien of that amount 
against the assets held. Hence, unless it treats the un¬ 
consumed portion of the consideration for the liability 
as an asset, it will not state its true financial status. 

What the value of an unexpired advertising contract 
is to a concern about to liquidate, depends naturally upon 
the terms of the contract itself. If it has been paid for 
in cash in advance of the performance by the advertising 
concern, a compromise agreement may be reached 
whereby the client will receive back a portion of his pay¬ 
ments, in consideration of the cancellation of the contract. 
The recording of such a transaction would consist in 
debiting cash with the amount received, debiting profit 
and loss with the loss (if any) represented by the excess 
paid in advance, under the contract, over the amount re¬ 
turned, and crediting the asset account “Advertising 
Contracts, Unexpired Portion.” 




DEFERRED DEBIT ITEMS 


3 ” 

If the business concern makes monthly payments, but 
has recorded the whole contract as suggested in the fore¬ 
going entry, and, upon a plea of impossibility to perform, 
has obtained a cancellation of the contract, the only ac¬ 
counting necessary will be to debit the liability account 
reflecting the amount still due under the contract, and to 
credit the asset account supposed to represent the right 
of the concern under the contract now canceled. This, 
of course, is true only if the two amounts are equal. 

If the contract is assignable, that is to say, if no pro¬ 
vision thereof opposes its being assigned, and if there is 
no liability to be incurred thereunder by the assignee, the 
concern assigning its rights will merely debit cash with 
the amount of the consideration received from the 
assignee. Any difference between the book value of the 
contract and the consideration for its assignment will 
be debited or credited (as the case may be) to profit and 
loss. 

Stable Supplies, Stationery and Printing, Advertising 
Matter 

The individual inventorial value of these assets may 
or may not be deemed important enough to be included 
in the balance sheet; still, the amount of an account 
should have no bearing whatever upon its treatment at 
the end of a period. Unless this principle is carefully 
applied at all times, the cost of operations of any given 
period may be incorrectly stated, to say nothing of the 
financial status of the concern. 

Stable supplies are obviously a valuable asset of a 
going concern as well as of a concern about to liquidate. 
In the latter case, they are subject to market fluctuations, 
and to the hazards of an auction sale; but they are at all 
events a legitimate asset. 

The value of stationery and printing is so problematic 


312 


THE THEORY OF THE ASSET ACCOUNTS 


to a going concern that the Insurance Department of the 
State of New York does not permit of its being shown in 
the balance sheet of insurance companies; the application 
of the unexpired portion of the account to any given 
period, involves the consideration of the proper time 
to charge to expense, books of account, records, and 
memoranda, which may outlive considerably the period in 
which they are put in use; furthermore, the question of 
obsolescence of type is forever present in the consideration 
of the inventorial value of the asset. As to concerns about 
to liquidate, the value of the asset to them is, of necessity, 
its scrap price. 

The value of advertising material remaining on hand 
at the end of a period, from the point of view of a going 
concern, is its cost. This, of course, is true only provided 
the advertising policy of the concern has undergone no 
radical change during the period. In the contrary case, 
the cost of the now obsolete material must be charged to 
profit and loss. To a concern about to liquidate, advertis¬ 
ing material is mere scrap. 

Clearing Partially Real and Partially Nominal Accounts 

Accounts partially real and partially nominal must be 
relieved periodically of their nominal portion, or of their 
real portion. In the first instance, they are considered as 
inventory accounts, the consumed portion of which is to 
be charged to profit and loss; in the second instance, they 
are considered as nominal accounts, which may or may 
not be entirely consumed for the purpose intended. If 
not entirely consumed, the real portion must be carried 
forward as an asset. In either case, the treatment is the 
same. It is not, however, necessary to wait until in¬ 
ventory time to determine the nominal portion of these 
accounts. If treated as inventory accounts they may be 
credited whenever part of the material which they contain is 



DEFERRED DEBIT ITEMS 


313 

issued to the stable, or to the different departments and 
offices of the organization as a whole. 

First Method 

The Stable Supplies account of a concern opens on 
January 1, 1914, with an inventory of $150; during the 
subsequent accounting period, there is purchased on 
credit, $500 worth of supplies. At the end of the period 
the inventory shows an asset of $75. The accounts 
affected by the transaction stated would show: 


Stable Supplies 

Account considered as inventory account or as a nominal account 
with a possible residual value. 


1914 

Jan. 1 Stable Supplies 

(Old Account) .$150.00 
June 30 Creditors. 500.00 


1914 

June 30 Profit and Loss. .$575.00 
Stable Supplies 
(New Account). 75.00 


$650.00 

July 1 Stable Supplies 

(Old Account) . $75.00 


$650.00 


Profit and Loss 

1914 

June 30 Stable Supplies.. .$575.00 

Second Method 

The Stationery and Printing account of a concern 
opens January 2, 1914, with an inventory of $300; during 
the period there is purchased on credit $250. In Febru¬ 
ary, $175 worth of material was issued to the adminis¬ 
trative department; in March, $50 worth was issued to 
the factory office. In May, $80 worth was issued to the 













314 THE THE0RY 0F THE ASSET accounts 

selling department. At the end of the period the status of 
the accounts affected by the above transactions is as 
follows: 


Stationery and Printing 


1914 

Jan. 2 Balance .$300.00 

June 30 Creditors.250.00 


$550.00 

July 1 Balance.$245.00 


1914 

Feb. 28 Stationery and 

Printing Ex¬ 
pended — Ad¬ 
ministration . .$175.00 
Mar. 31 Stationery and 

Printing Ex¬ 
pended — Fac¬ 
tory Office ... 50.00 

May 30 Stationery and 

Printing Ex¬ 


pended — Sell¬ 
ing . 80.00 

June 30 Balance.245.00 


$550.00 


Stationery and Printing Expended—Administration 


1914 

June 30 Stationery and 

Printing.$175.00 


Stationery and Printing Expended—Factory Office 


1914 

June 30 Stationery and 

Printing.$50.00 


Stationery and Printing Expended—Selling 


1914 

June 30 Stationery and 

Printing.$80.00 
























DEFERRED DEBIT ITEMS 


315 


Deferred Debit Items 

The expenses and losses incurred and sustained during 
a given period, may not apply to that particular period; 
if, for instance, an accounting period comes to a close on 
June 30, and during that month there has been paid $150 
for rent of June and July, it is obvious that the applica¬ 
tion of $75 to the rent expense must be deferred until the 
subsequent period. Similarly, if a note maturing three 
months from June 15 has been discounted on that day, 
the loss of the discount cannot be made to fall upon the 
month of June, but must be spread over the three months 
ending September 15. 

The items which may be properly included among the 
deferred debits, are not assets in the strict sense of the 
word, since the question of their availability never arises. 
So far as the average business is concerned, they represent 
expenses which have no residual value other than the 
benefits for which they have paid but which will be en¬ 
joyed only in subsequent periods, or losses which respect 
for the accounting truth requires to be apportioned to the 
periods to which they legitimately belong. 

The Interstate Commerce Commission has greatly 
extended the generally accepted meaning of the word 
“deferred” when applied to accounts; and this will be re¬ 
ferred to again when speaking of the effect of the com¬ 
mission’s rulings upon accounting theories and methods. 

Generally speaking, deferred debit items include: 

1. Rent paid in advance 

2. Taxes paid in advance 

3. Interest and discount, proportion applicable to 

subsequent periods 

4. Premiums paid on investments 

5. Discounts suffered on issues of long-term obliga¬ 

tions 


316 THE theory of the asset accounts 

The treatment of these accounts at the end of the ac¬ 
counting period, consists merely in crediting them in¬ 
dividually with the portion applicable to the operations 
the result of which it is intended to ascertain, and debiting 
profit and loss, or group accounts raised to be apportioned 
to other general classes of facts. 

Desire for analytical expression of financial facts has 
often led accountants to classify deferred debits in ac¬ 
cordance with the effect which they will have upon the 
financial statements of future periods. They have at 
times been stated as follows: 

1. Deferred debits to Operating Expenses 

2. Deferred debits to Deductions from Income 

3. Deferred debits to Profit and Loss 

Organization Expense 

What the components of each group of deferred debits 
will be, depends naturally upon the peculiarities of the 
business. To illustrate, as to group 3, one of the most 
familiar of the factors which it may contain, is organiza¬ 
tion expense. 

At the birth of a corporation, a multitude of expenses 
are incurred which are necessary to fulfill statutory re¬ 
quirements, and to set in motion the mechanism of the 
corporate body and the operations of its business. 

The first group of such expenses includes the fees paid 
for incorporation, and for the filing and acknowledging of 
papers. 

The second group includes the fees paid to the pro¬ 
moter for his services, and to the lawyer for conducting 
the organization in a legal manner; also the cost of print¬ 
ing and circulating prospectuses, and of soliciting sub¬ 
scriptions; the cost of acquiring the necessary corporate 
equipment, such as corporate records, seal, etc.; the cost 


DEFERRED DEBIT ITEMS 


317 


of printing and issuing certificates of stock, and the cost 
of conducting the temporary office of the company pend¬ 
ing organization. 

The third group includes perhaps the cost of inducing 
skilled superintendents, foremen, and workingmen to 
abandon their present occupation, and to enter the em¬ 
ploy of the company. 

There is no doubt that the benefits derived by the 
corporation from these expenditures will be felt so long 
as it remains actively engaged in business. This is so 
true that the Italian law does not permit corporations to 
write off their organization expenses otherwise than pro¬ 
portionally during their official life, which extends for 
fifty years. In America, where perpetuity of corporate 
life is usually granted, it would not be possible to apply 
such a rule. On the other hand, unless the expenses of 
organization are written off during a certain number of 
periods, the balance sheet will forever contain an asset 
which has no salable value and which does not in any way 
tend towards the proper presentation of the financial 
status. Hence, it is customary to arbitrarily fix a number 
of years for the amortization of organization expenses. 
This is done by periodically crediting the account with 
the desired proportion, and charging profit and loss. 

The Public Service Commission for the first district 
of the State of New York prescribes that the corpora¬ 
tions organizing under its jurisdiction, keep an account 
with “Organization,” to which shall be charged “all fees 
paid to governments for the privilege of incorporation, 
and all office and other expenditures incident to organ¬ 
izing the corporation or other enterprise and putting it 
in readiness to do business.” On the other hand, the 
Interstate Commerce Commission requires that these ex¬ 
penses be included in the cost of construction and 
equipment. In Austria and Hungary the corporation is 


318 the theory of the asset accounts 

permitted to assess stockholders in the amount necessary 
to wipe off the expenses incident to the organization of 
the company, while in Germany the same purpose is ob 
tained by selling stock at a premium calculated to defray 
the cost of organizing. 


Part IV—The Theory of the Liability Accounts 


CHAPTER XXVII 

CAPITAL STOCK 

The Share and Its Functions 

In America a corporation may exist without issuing, 
under the form of shares, evidences of the contribution 
of capital by its members; it is understood, however, that 
in order that such corporations—which are known as 
“corporations aggregate”—may enjoy a perpetuity of life, 
the rights of the original members to the capital con¬ 
tributed by them, shall pass to their successors together 
with the property acquired out of capita 1 and with the 
corporate privileges. 

Generally speaking, corporations issue shares of stock 
to their stockholders, which, at the time of such issue, 
indicate the extent of the contributions of the stock¬ 
holders, and, thereafter, the proportion in which the 
holders whose names are registered on the corporate 
books will participate in the distribution of profits while 
the company continues as a going concern, and in the 
remainder of the assets and surplus after liquidation of 
the liabilities at winding up. 

Lindley, in his work on “Partnerships,” refers to 
capital stock as follows: “When a company is formed, 
a sum of money is fixed upon, and is called its capital; 
this sum is divided into a number of equal portions; each 

319 



320 THE THEORY OF THE LIABILITY ACCOUNTS 

of these portions is a share, and whether the sum fixed 
upon is ever all subscribed or not, and whether what is 
subscribed is employed profitably or to the contrary, a 
share retains its original meaning.” 

If a share of stock has a meaning when issued, that 
meaning must be that the legal entity which issues the 
document intends it as an evidence of its indebtedness to 
the original holder, his heirs, or assigns, for the net assets 
acquired out of the capital originally contributed and out 
of the reinvestment of undivided profits. If this were 
not true, the legal doctrine which holds that the title to 
the assets of a corporation rests in the corporation, would 
be meaningless, and the stockholders would be tenants in 
common, precisely like partners. 

Capital Stock as a Liability 

The fact that capital stock is truly a liability, is in¬ 
sisted upon, because of the spread in recent years of an 
academic theory which attempts to establish a distinction 
between “liabilities” and “accountabilities.” It main¬ 
tains that capital stock, surplus, and reserves are “ac¬ 
countabilities” which merely measure the extent of the 
stockholder’s “proprietorship” in the assets of the 
corporation. It makes the corporate balance sheet sub¬ 
servient to the following formula of double-entry book¬ 
keeping, which is only expressive of the nature of the 
proprietor’s equity: “Assets less liabilities, equal proprietor¬ 
ship.” 

So far as sole traders are concerned, they are un¬ 
questionably the owners of that part of the assets which 
will not be consumed for the liquidation of liabilities. 
Hence, for these two classes of business organization, the 
balance sheet is nothing more than the classified and 
detailed expression of the above-mentioned bookkeeping 
formula. 


CAPITAL STOCK 


321 


The proprietors have invested in the business the 
whole or part of their wealth, consisting of real or personal 
property, or both; their business is not an entity which 
the law recognizes; it is not a “person” in any sense of 
the word, not even in contemplation of law; it owns 
nothing, owes nothing, and is nothing. The expression 
“My business is prosperous” means nothing more than 
“I am prosperous in business.” The invested assets of a 
sole trader may be seized, upon due process of law, by 
anybody who has a valid claim against the owners of the 
equity in the investment, as measured by the result of 
the subtraction of the liabilities from the assets. 

As to copartnerships the same rules apply, with this 
exception: they are entities which the law recognizes only 
to the extent of permitting the individual creditors of 
the partners to share only in the assets which have not 
been used to liquidate the debts of the copartnership. 

The corporation, on the other hand, is an entity, none 
the less real because it is invisible and intangible. It is 
a legal being invested with a written permit to exist, to 
possess, to contract, to sue, to be sued, and, generally 
speaking, to conduct the particular business for which it 
is created. 

To fulfill its purpose a corporation requires capital 
Since it has nothing at birth but the power to act as a 
human being for a far longer period and with a greater 
continuity of purpose than is the lot of mortals, it must 
obtain capital through the contributions of those who 
believe in its ultimate fortunes and in the adequacy of 
its special organism for the fulfillment of its particular 
purpose; or if this is not sufficient, it must finance itself 
as best it can, by pledging as security the assets obtained 
through the investment of moneys contributed by its 
sponsors. It goes without saying that if it were true 
that the stockholders own the corporate assets, the cor- 


322 THE theory of the liability accounts 

poration could not violate the law and pledge that which 
it does not own. Indeed, the peculiarity of the status of 
the legal being known as the corporation, is that it owes 
everything which it owns. 

To show to what extent the anonymous sponsors of 
the corporation have equipped it with its original capital, 
there is issued to them shares of capital stock which be¬ 
come the personal property of the stockholders, precisely 
as the assets acquired by means of that capital become 
the real or the personal property of the corporation. 

The issue of stock measures the extent of the cor¬ 
poration’s liability for original capital, or for subsequent 
increases thereof. The stockholders hold that evidence 
of the corporate liability to them, but they have absolutely 
no title to the assets. They cannot re-enter into posses¬ 
sion of them otherwise than by causing the death of the 
legal being whose birth they have brought about. Their 
individual creditors cannot seize any asset of the corpora¬ 
tion to satisfy their claims against the stockholders. 
They can, however, by due process of law, secure for 
themselves the stockholdings of their debtors. These 
stockholdings measure their owner’s evidence of the cor¬ 
poration’s liability: 

1. At winding up, for money, property, or services 

originally contributed, as represented by the 
capital stock outstanding, expressed at par. 

2. Also at winding up, or at any time deemed ad¬ 

visable by the corporation speaking through its 
directorate, for increments arising from the re¬ 
investment of undivided profits, as measured by: 

a. The surplus 

b. Such reserves as do not contain : 

(i) Losses temporarily withheld from the 
asset which they would otherwise 
reduce (reserves charged to cost) 


CAPITAL STOCK 


323 


(2) Losses incurred but not as yet paid 
through the outgo of an asset 
(operating reserves such as, “For In- 
juries ) 

i.e., all the reserves appropriated out 
of surplus. 


Capital Stock Records 

The rights of the stockholders to the benefits accruing 
from the profitable employment of the capital represented 
by their shares, is closely safeguarded by statutes. The 
total amount of the capital stock indebtedness which the 
corporation may incur, is well known, since the charter 
states it, and it cannot be increased in violation of the 
rights of the original contributors. Indeed, if the 
authorized amount of capital stock is overissued, the pur¬ 
chasers of the excess do not acquire any rights whatever 
as stockholders, although they may have a cause of action 
for damages against the corporation for any harm done 
to them. Thus, so far as accounting is concerned, the 
financial books of a corporation must be so kept as to 
reflect at all times the authorized issue of capital stock, 
the amount actually issued, and the balance unissued, 
otherwise known as “potential stock.” This can be done 
in two ways: 

1. At the time of opening the books, make a pro 
forma journal entry stating fully the authorized issue, 
divided into as many classes of stock as the charter con¬ 
templates, and, thereafter, frame an explicit pro forma 
entry whenever an authorization to increase the issue is 
obtained. When this is done, a reference to the journal 
will give the total authorized issue, even though the 
minute book is not available. As to the portion of that 
authorized issue which is actually outstanding, it will be 


324 THE ™ E0RY 0F THE liability accounts 

given by the sundry accounts with the sundry classes of 
capital stock, which will be credited at the time of issuing. 

Expressed in journal form, the requirements of this 
method might appear as follows: 

The A. B. C. Company 
General Journal 

January 2, 1914 

The A. B. C. Company, incorporated under 
the laws of the State of New York, with an 
authorized capital stock of five hundred thou¬ 
sand dollars ($500,000) divided into five thou¬ 
sand (5,000) shares of common stock, of the 
par value of one hundred dollars ($100) per 
share, with express and implied power to con¬ 
duct a general manufacturing business. 


Cash . $ 75,000.00 

Property, Plant, and Sundry Assets. 325,000.00 

To Capital Stock. $400,000.00 


For issue of capital stock in consideration of 
cash subscriptions to 750 shares and of 
property, plant, and sundry assets acquired 
from John Harrison, as per contract on 
file. 

The balance sheet of the company would show: 


Balance Sheet 


Assets 


Liabilities 

Cash . 

$ 75,000.00 

Capital Stock 

Property, Plant, and 


Authorized. $500,000.00 

Sundry Assets. 

325,000.00 

Less Unis- 

• 


sued . 100,000.00 



Issued and 0utstanding.$400,000.00 


$400,000.00 

$400,000.00 

















CAPITAL STOCK 


325 


2. When opening the books, state the “potential stock” 
as a debit representing the right of the company to issue 
the stock, and as a credit representing the extent of the 
stock liability which the corporation has been authorized 
to mcur. The names to be borne by the two classes of 
statistical accounts may be: 

Debits: 

Unissued Capital Stock—Common 
Unissued Capital Stock—Preferred 
Credits: 

Capital Stock Authorized—Common 
Capital Stock Authorized—Preferred 

Subsequently, when capital stock is issued, debit the 
particular asset obtained as a consideration for the issue, 
and credit the “unissued” account. By itself, the balance 
of the unissued account represents the extent of the poten¬ 
tial stock, and when deducted from the “authorized” ac¬ 
count, it measures the actual capital stock liability of the 
corporation. 

Authorized Capital Stock—Common 

Unissued Capital Stock 
—Common .$500,000.00 


Unissued Capital Stock—Common 


Authorized Capital 

Cash . 

-$ 75,000.00 

Stock—Common ... $500,000.00 

Property, Plant, 

and 


Sundry Assets.. 

- 325,000.00 


Cash 

Unissued Capital Stock 
—Common. $75,000.00 


Property, Plant, and Sundry Assets 

Unissued Capital Stock 
—Common.$325,000.00 














326 THE THEORY OF THE LIABILITY ACCOUNTS 

If all the authorized issue of capital stock has been 
subscribed, partially paid for, and issued subject to subse¬ 
quent calls, the whole authorized issue constitutes a lia¬ 
bility of the corporation and must be so stated. The rea¬ 
son for this accounting treatment is to be found in the 
spirit of the law regulating corporate bodies. A sub¬ 
scriber to capital stock who has received the stock upon 
partial payment of its price, has no power to surrender his 
shares. Corporations may, indeed, exercise the power to 
make bona fide compromises with subscribers when their 
doing so does not jeopardize the interest of third parties; 
they may also forfeit the shares issued to individual stock¬ 
holders who have defaulted on the payment of calls legally 
made; but generally speaking, the doctrine prevails that 
corporations have not power to release a subscriber from 
the obligations incurred under his subscription contract. 
The reason for the denial of that right is that the unre¬ 
strained exercise thereof would work to the prejudice of 
other subscribers and creditors. 

If all the stock has been subscribed, partially paid for, 
and issued subject to subsequent calls, the application of 
the requirements of the second method described above 
will give: 


Capital Stock Authorized 

(One account for each class of stock) 


Unissued Capital 
Stock. 


$500,000.00 


Unissued Capital Stock 

(One account for each class of stock) 


Capital Stock Author¬ 
ized . 


Capital Stock Sub- 
$500,000.00 scribed . 


$500,000.00 


















CAPITAL STOCK 


327 


Subscriptions to Capital Stock 

(One account for each call) 


Capital Stock 
scribed . 

Sub- 

.$500,000.00 

Calls i and 2. $250,000.00 

Balance (Uncalled 
subscriptions). 250,000.00 


$500,000.00 

$500,000.00 

Balance. 




Capital Stock Subscribed 

(One account for each class of stock) 

Unissued Capital Subscriptions to Capi- 

Stock. $500,000.00 tal Stock. $500,000.00 


Cash 

Subscriptions to Capi¬ 
tal Stock, Calls 1 
and 2. $250,000.00 

and the balance sheet expressing the above facts will be: 


Balance Sheet 


Assets 

Cash . $250,000.00 

Uncalled Subscriptions 250,000.00 

Liabilities 
Capital Stock Author¬ 
ized, issued and out¬ 
standing . 

$500,000.00 

$500,000.00 


$500,000.00 


If all the authorized issue of capital stock has been sub¬ 
scribed, and partially paid for, and the stock remains un¬ 
issued until all the subscriptions have been paid, the facts 
will be expressed as follows: 

Capital Stock Authorized 

Unissued Capital Stock.$5oo,000.00 











































328 THE THEORY OF THE LIABILITY ACCOUNTS 

Unissued Capital Stock 

Capital Stock Author¬ 
ized .$500,000.00 


Subscriptions to Capital Stock 


Capital Stock Sub¬ 
scribed . 


Cash 


$500,000.00 


$250,000.00 


Capital Stock Subscribed 

Subscriptions to Capi¬ 
tal Stock . $500,000.00 


Cash 

Subscriptions to Capi¬ 
tal Stock. $250,000.00 


and the balance sheet will show: 


Balance Sheet 


Assets 

Liabilities 

Cash . $250,000.00 

Capital Stock 

Uncalled Subscriptions 250,000.00 

Authorized. $500,000.00 

Less: Unis- 


sued. 500,000.00 


Capital Stock Sub- 

• 

scribed .$500,000.00 

$500,000.00 

$500,000.00 


This, it will be noticed, is equivalent to stating that 
the corporation is not as yet liable to stockholders for 
stock issued, but that it will become so liable to them as 
soon as they have performed their share of the subscrip¬ 
tion contract. 


































CAPITAL STOCK 


329 


The Status of Unissued Stock 

Teachers of accounting maintain that unissued capital 
stock is expressive of nothing but a corporation’s right of 
issue under its charter; that it is not an asset any more 
than the admitted capability of an individual to earn 
$10,000 a year is an asset of his until he has actually 
earned the amount; that it is not a liability any more than 
the possibility of mortgaging a parcel of real estate is a 
liability until a sum of money has been borrowed and the 
property has actually been mortgaged. If their conten¬ 
tion is based upon the status of the certificates still at¬ 
tached to the stubs in the stock certificate book, it is 
undoubtedly true. If, however, the certificates have been 
detached from the stubs, signed, sealed, assigned in blank, 
and placed with transfer agents or other financial officers, 
ready for sale and delivery, there is at least one excellent 
reason for considering the shares they represent both as 
an asset and as a liability; it is that the Interstate Com¬ 
merce Commission requires that they be so treated for 
balance sheet purposes. On page 26 of its pamphlet 
“Form of General Balance Sheet Statement for Steam 
Roads,” and under the subheading “Capital Stock” of the 
general heading “Liabilities,” it says: 

“The amounts included in this account should be 
divided so as to show: (1) The par value of certificates 
(pledged or unpledged) held in the company’s treasury, 
by its agents or trustees, or otherwise subject to its con¬ 
trol.” On the same page, there is a footnote to the effect 
that, “for the purposes of the balance sheet statements, 
stock is considered as ‘issued’ when certificates are signed 
and sealed, and placed with the proper officer for sale and 
delivery.” 

Premiums on Capital Stock 

Generally speaking, statutes do not permit capital 



330 THE THEORY OF THE LIABILITY ACCOUNTS 

stock to be issued for less than par; hence, so far as the 
issue of stock to subscribers is concerned, it is unusual 
for a corporation to incur a capital stock liability greater 
than the consideration therefor. It is, however, quite fre¬ 
quent that subscriptions realize more than the par value 
of the stock. How are the premiums on stock to be con¬ 
sidered, in the light of the principle that the capital stock 
liability is to be carried at par? 

Premiums realized on capital stock are neither income 
nor profits, since the word income means, that which has 
come in as a result of the investment of capital in any 
form whatever; while the word profit means that which 
has come in, in excess of the cost of the capital which has 
been sold. Premiums do not represent the excess of cap¬ 
ital obtained in exchange for a liability, but the excess ob¬ 
tained over the par value of the shares of stock expressive 
of that liability. This is true in any event; it does not 
matter whether the premiums were obtained at the time 
of the original subscription, or subsequently upon the sale 
of the unsubscribed portion of the original authorized 
issue, or again upon sale of a properly authorized in¬ 
creased issue. 

The treatment of premiums on capital stock as a profit, 
places the corporation in the position of admitting that it 
has been guilty of sharp practices upon its stockholders. As 
a consequence, it will have to return to the stockholders that 
which it has exacted from them in excess of the par value 
of the liability which it has incurred towards them. If 
dividends are declared out of premiums on capital stock, 
and the cash which the premiums placed at the disposal of 
the corporation is returned to the stockholders, where is the 
advantage of such financing? 

Premiums on capital stock should no more be sent to 
the credit of the Profit and Loss account than they should 
be sent to the surplus available for dividends. It has been 


CAPITAL STOCK 


331 


suggested that they be credited to a special account so ear¬ 
marked as to indicate that it is not available for distribu¬ 
tion. But is not this an admission that these premiums con¬ 
stitute a liability of the corporation? As a matter of fact, 
premiums obtained on the issue of stock which has a par 
value are a capital stock liability precisely as they would 
be if the stock had no par value, and there was no account¬ 
ing objection to stating the capital stock at the amount of 
its proceeds. And is it not because the fact that premiums 
on capital stock constitute a liability, cannot be denied, that 
the Interstate Commerce Commission requires that they be 
treated as such by the public service corporations which 
come under its jurisdiction? The commission has ruled as 
follows: “When any issue of capital stock is sold or ex¬ 
changed by or for the respondent company for a considera¬ 
tion the actual value of which exceeds the par value of the 
stock at the time of such sale or exchange, the premium so 
realized should be credited to a ledger account provided for 
discounts and premiums on all classes of stock sold. If the 
net balances in the accounts for discounts and premi¬ 
ums on all classes of stock sold is a credit balance, tbe 
amount should be included in this account. This balance 
should be carried permanently on the balance sheet unless 
extinguished by discounts suffered on subsequent sales of 
stock, or by retiring stock. When any stock is retired, the 
proper discounts and premiums account should be adjusted 
by debiting it with an amount equal to the extinguished 
premium on such stock.” 

Discount and Premium Accounts 

If premiums are to be carried permanently on the credit 
side of the balance sheet, it follows that, for the sake of con¬ 
sistency, discounts should be carried permanently on the 
asset side as a partial offset to the liability expressed at the 
par of the shares, instead of being debited to profit and 


332 THE theory of the liability accounts 

loss, in either a lump sum or throughout a period of years. 
The net amount paid by the stockholders for their stock is 
indeed that which they may expect to receive at winding up, 
irrespective of the dividends declared in the past. This is 
true whether or not the company has legally or illegally ac¬ 
cepted as payment in full the consideration for the stock 
paid by the stockholder. 

In regard to discounts on capital stock, the Interstate 
Commerce Commission has ruled that “if the net of the 
balances in the discounts and premiums accounts for all 
classes of capital stock sold is a debit balance, the amount 
should be stated in this account (Unextinguished Discount 
of Capital Stock). This balance should be carried on the 
balance sheet (asset side) until extinguished by premiums 
realized on subsequent sales of stock, by assessments levied 
on the stockholders, by appropriations of income or free sur¬ 
plus for the purpose, or by retiring the stock. When any 
stock is retired, the proper discount and premium account 
should be adjusted by crediting to it an amount equal to the 
unextinguished discount on such stock.” 

Treasury Stock 

Capital stock which has been legally issued is looked 
upon by the law as a liability of the corporation issuing it, 
until it has been liquidated, on the winding up of the cor¬ 
poration, through the distribution to the stockholders of the 
remainder of the assets after liquidation of all liabilities to 
outsiders, or until it has been legally canceled after author¬ 
ization given by the stockholders assembled at a meeting 
legally called to consider the cancellation. It follows that 
if stock has been acquired in the open market by the company 
responsible for its issue, in pursuance of some financing 
scheme, or donated to the company by the stockholders to be 
resold for the purpose of obtaining additional capital, such 
stock must be an asset. It is not “potential stock,” since 


CAPITAL STOCK 


333 


it has been issued; it is “actual stock” held in the treasury 
pending disposition. It is usually carried as “treasury 
stock,” but the term does not seem to be satisfactory, be¬ 
cause it conveys to many the idea that it represents stock held 
in the treasury, whether or not it was once issued. It might 
be more in keeping with the efforts of modern accountancy 
to make financial statements intelligible both to the layman 
and to the professional accountant, if stock acquired by, or 
donated to, the issuing company were to be called “stock 
issued, acquired (or donated), and held in the treasury,” 
or “actual stock held in the treasury.” 

If stock which has been legally issued and has come back 
into the treasury is subsequently canceled upon due author¬ 
ization of an assembly of stockholders, it ceases to be treas¬ 
ury stock; it reduces the liability for outstanding stock, and 
becomes potential stock precisely like the previous balance 
(if any) of the unissued authorized capital stock. 

Accounting for Treasury Stock 

A business concern acquiring its own stock in the open 
market, either to sell it later at a higher price than was 
originally obtained therefor, or to avoid the payment of 
large dividends earned and about to be declared, will in all 
probability carry treasury stock at par, since its par value is 
the exact counterpart of the liability therefor, expressed at 
par. If the price paid has been greater or smaller than 
par, it may debit or credit the “loss” or the “gain” to the 
Profit and Loss account, or carry it in a special account, 
“Premiums and Discounts on Treasury Stock,” subject to 
periodical amortization. The result of such an accounting 
will be an additional profit or loss for the period during 
which the stock was purchased, or for a certain number of 
periods thereafter. But if that additional profit or loss 
means anything, it means that by “dabbling” in its own 
capital obligations the company has been benefited or in- 


334 


THE THEORY OF THE LIABILITY ACCOUNTS 


jured to a certain extent. No matter what the financing 
scheme may have been which suggested the purchase of 
stock, its purpose should have been accomplished without 
affecting the income, since the question of reducing the 
capital stock liability was never at issue. It would undoubt¬ 
edly be better accounting to accept the view that premiums 
on capital stock constitute liabilities, while discounts con¬ 
stitute assets, or, at all events, that they represent facts 
which should be permitted to remain on the books until 
offset by subsequent transactions. Nor can it be said that 
such a treatment would not be good financing, since it would 
compel the supposed gains on discounts to remain, in the 
business, while it would prevent the supposed losses on 
premiums from being charged to the present stockholders to 
the possible advantage of future stockholders. 

Donation Account 

A business concern coming into possession of its own 
stock through a donation, should carry the stock at par under 
the term “Treasury Stock,” and create a credit account bear¬ 
ing an appropriate name, as, for instance, “Treasury Stock 
Donation Account,” which will remain open so long as all 
the treasury stock is not disposed of. As sales occur, the 
treasury stock account should be credited with the par 
value of the shares sold, and the donation account debited 
with the discounts and credited with the premiums, if any. 
If treasury stock is given as a bonus to syndicates under¬ 
writing issues of bonds, or to purchasers of bonds or other 
classes of stock, the par value of the shares so given should 
be credited to the treasury stock account and debited to the 
donation account. Thus, when all the treasury stock is 
disposed of, the balance of the donation account will reflect 
the exact amount of working capital obtained by the com¬ 
pany as a result of the gift, and the question of what to do 
with the donation account will arise. 


CAPITAL STOCK 


335 


If the balance of the donation account is sent to the free 
surplus, dividends will be declared therefrom and the pur¬ 
pose of the donors will be defeated. If the balance is sent 
to a separate surplus account so earmarked as to indicate that 
it is not available for dividends, what will be the nature of 
that account ? It has been suggested that it practically con¬ 
stitutes a reserve susceptible of being transferred to surplus, 
if required to offset extraordinary losses of a given period 
or of a succession of periods. This may be “sentimental 
accounting” but it has no other quality. It fails to respect 
the purpose of the donation; it jeopardizes the benefits ob¬ 
tained .thereby in so far as it makes it possible to declare 
dividends which will have to be paid out of the additional 
working capital obtained as a result of a gift made for the 
welfare of the corporation. 

In reality, the donation account measures the extent of 
the benefit derived by the stockholders present and to come 
from the benevolent action of one or several of them, and 
constitutes a capital liability of the corporation similar in 
every respect to the liability for unextinguished premiums 
obtained through the sale of stock. 


CHAPTER XXVIII 


BONDED DEBT 
General Considerations 

Taken in its broadest sense, the word “debt” means a 
fixed and certain sum of money due, or owing, by virtue of 
express agreement. The distinction between “due” and 
“owing” has been established by a California judge* as 
follows: 

“Standing alone, the word ‘debt’ is as applicable as well 
to a sum of money which has been promised at a future day, 
as to a sum of money now due and payable. If we wish to 
distinguish between the two, we say of the former that it is 
a debt owing, and of the latter that it is a debt due. In 
other words, debts are of two kinds: solvendmn in praesenti, 
and solvendum in futuro” 

The same judge, speaking of the nature of debts, says 
in the same case: “Whether a claim or demand is a debt or 
not, is in no respect determined by a reference to the time 
of payment. A sum of money which is certainly and in all 
events payable, is a debt, without regard to the fact whether 
it be payable now, or at a future time. A sum payable upon 
a contingency, however, is not a debt, or does not become a 
debt until the contingency has happened.” \ 

All debts which are evidenced by securities of a 
permanent nature and for the payment of which certain 
property has been pledged, are generally referred to as 
“funded debt,” even though it be true that the term appears 

* In People v. Arguello, 37 Cal. 524, 525. 

336 



BONDED DEBT 


337 


to suggest that the payment of the debt is secured beyond 
peradventure by the periodical appropriation of money. 
Such an appropriation may or may not exist; if it does not, 
the term “funded debt” applies just as surely to treasury 
bonds and stocks, mortgage bonds, collateral trust bonds, 
equipment certificates, etc., etc., since the debt is to all intents 
and purposes, funded through the pledge of a particular 
property which may be converted by sale into cash funds. 

In this book, however, it has been deemed advisable to 
subdivide funded debt as follows: 

1. Bonded Debt, i.e., all debts evidenced by bonds. 

2. Mortgaged Debt, i.e., all debts evidenced by bonds 

secured by mortgages on real estate or on chattels. 

Bond Issues 

Every corporation not restricted by constitutional pro¬ 
visions of its own making or by statute, has the implied 
power to issue bonds as evidence of indebtedness incurred 
for money borrowed, property acquired, labor performed, or 
financial services rendered by others for its benefit. 

This corporate privilege is exercised through the vote of 
the stockholders, or, if the latter have vested part of their 
rights in the directorate, through proper resolutions by the 
board of directors. 

Bonds are authorized to be issued in denominations best 
suited to the conditions of the market in which they will be 
offered for sale. Issues of bonds may be composed of units 
all maturing at the same date, or of a series of units each 
series maturing at a different date; in the latter case, the 
security pledged under the issue as a whole is all the more 
attractive because the retirement of a particular series 
usually causes the part of the pledge securing it to revert 
to other unmatured series. 

The mortgage securing the bonds is frequently issued to 
one or several trustees who hold it for the common good 


238 THE THEORY of the liability accounts 

of the bond purchasers; in many instances the indenture 
states conditions which must be fulfilled before the trustees 
are allowed to certify bonds for sale to the public. These 
provisions are common in modern railroad bonds issued for 
construction purposes where the trustee can only certify 
such instalments as cover the completion to date of a stated 
part of the construction. 

Accounting Theories of Bond Issues 

The accounting record of the liability incurred under an 
issue of bonds, depends upon the point of view of the 
accountant: 

1 Considering the potential value of bonds as secured 
evidences of the indebtedness, and accepting them 
individually as pro rata representatives of a valu¬ 
able mortgage, he may give to the unsold part of 
the issue an asset value derived from its potential * 
pledge value, and, for financial purposes, treat it 
as an asset. 

2. He may hold the opinion that, being executed to the 

trustee, whether or not subject to his certification, 
the unsold portion of the proposed issue differs 
from the sold portion only in the fact that in the 
latter instance the cash value of the mortgage has 
been realized, whereas in the former case it has 
not. 

3. Ignoring the borrowing power inherent in the un¬ 

sold instruments of credit, and refusing to be 
swayed in his opinion by the argument that 
whether or not the whole issue is sold the same 
amount of assets remain pledged, he may rigidly 
enforce the rule that potentiality does not mean 
actuality. 

Under the first and second hypotheses, the accounting 
treatment will be the same; the whole authorized issue will 


BONDED DEBT 


339 


be carried as treasury bonds, and at the same time as a 
liability. The liability will remain immutable until its 
maturity, or until premature cancellation of part of the 
evidence of indebtedness; as to the asset, its nature will 
change with every successive sale. 

Under the third hypothesis, the asset and the liability 
will be recorded only at such time as the former has been 
received in cash through sales. 

It is evident that either of the above treatments would 
produce the same impression upon the reader of a balance 
sheet were it not that, thanks to theorists and philosophizers, 
the general public has come to give to the term “treasury 
bonds” the same meaning as is commonly given to “treasury 
stock.” The layman understands treasury bonds to be 
bonds issued and subsequently reacquired by the issuing 
company. The objection is only a trivial one, however, 
since for balance sheet purposes it is always possible to 
record the status of bonded indebtedness as follows: 

First Mortgage 5 per cent Bonds of 1925: 

Authorized.$100,000.00 

Less held in Treasury. 40,000.00 

■ 1 1 1 —* 

Issued and Outstanding.. . $60,000.00 

Bonds Acquired by Issuing Company 

The question of the status of bonds purchased by the 
issuing company, for sinking fund purposes or for any 
other purpose, has usually found the accountant quite in¬ 
different. Instinctively, he has felt that it is of bonds as it 
is of stocks, i.e., neither uncanceled bonds nor uncanceled 
stocks reduce the liability of the issuing company. 

Unquestionably, if the purpose in acquiring the bonds is 
to hold them for speculative purposes, the liability of the 
company remains unaffected. 

But when we come to consider the status of bonds ac- 





340 THE theory of the liability accounts 

quired by the issuing company for the purpose of the sink¬ 
ing fund, we face a much more complicated situation. It is 
plain that at maturity of the bonds the liability will auto¬ 
matically be reduced by the amount of the par value of 
bonds held by the trustee of the sinking fund. But it is 
just as plain that if the par value of the bonds acquired 
under the sinking fund provisions of the indenture is de¬ 
ducted from the liability, the accounting correlation which 
should exist between the sinking fund and the expired por¬ 
tion of the life of the bond liability representing the whole 
issue, will be lost. And yet the bondholders who read the 
balance sheet have the right to know the status of the 
sinking fund. 

C. S. Ludlam, C. P. A. (N. Y.), writing in the March, 
1914 number of the Journal of Accountancy, makes a plea 
for the acceptance of the theory that sinking funds composed 
of uncanceled bonds of the company responsible for their 
issue are to be shown as deductions from the liability. 

Mr. Ludlam says: “It is appreciated that some of our 
legal friends will claim that bonds of a mortgagor, of the 
issue covered by a sinking fund, purchased by the sinking 
fund trustee and not retired and canceled, will not reduce the 
obligation of the mortgagor, and that such bonds should be 
treated as a part of the sinking fund and shown on the 
balance sheet of a corporation as an asset, and that, contra 
thereto, the full amount of the bonds, both outstanding and 
in the sinking fund, should be shown as a liability. It is 
admitted that there are some legal reasons for this, the 
chief of which is perhaps the question of legal practice in 
regard to the burden of proof, but it seems to me that ques¬ 
tions of this nature could arise only in cases of receivership 
or liquidation and would have to be dealt with only under 
court orders; consequently they would not apply to the 
ordinary accounting of a going concern. Further, while 
accountants must be mindful of any and all legal obligations, 


BONDED DEBT 


341 


and of any legal situation affecting the accounts of the 
clients, it will be apparent at once to anyone who gives the 
matter thought, that as an actual fact an individual cannot 
owe money to himself.” 

Many people have given thought to bond accounting, 
and, judging from the rulings of the Interstate Commerce 
Commission, the commissioners have given to the particular 
subject of sinking funds all the respectful attention which it 
deserves. A sinking fund is, after all, an account to which 
nothing else can happen but to be eventually debited to the 
liability for the redemption of which it is created. Hence, 
it is essentially and wholly an item the ultimate disposition 
of which is deferred until such time as its contra will mature. 
For this reason public utility corporations must show sink¬ 
ing funds as deferred debit items. 

Nobody reading a balance sheet would be led to shrug 
his shoulders contemptuously at the anomaly presented by 
a sinking fund which, if examined under a sophistical micro¬ 
scope, would elucidate the fact that it contains evidence of 
indebtedness of the company to itself. One would simply 
understand that, no matter what particular asset the sinking 
fund may contain, it represents an accumulation of future 
debits to a liability account. As to the accountant, he would 
naturally, knowing the date of issue and the maturity of the 
bonds, divide the total liability by the sum of its life in 
years or in interest periods, or in accounting periods, multi¬ 
ply the result by the number of periods of expired life of 
the liability, and judge the sinking fund in the light of the 
ratio that it bears to the liability which it will redeem. 

Premiums and Discounts on Bond Sales 

When bonds have been sold at par, the recording of the 
liability therefor consists in expressing it at the same figure 
as the asset which represents the proceeds of the sale. But 
when bonds are sold at more, or at less, than par, there has 


342 THE theory of the liability accounts 

been obtained an asset greater or smaller than the liability, 
and we must record the extent of the excess or of the 
shortage under the name of premiums or discounts on 
bonds. What to do with these discounts or premiums is 
one of the most interesting of the problems which the ac¬ 
countant has to solve. 

Let us state at once that the universal custom is to credit 
the premiums and debit the discounts to profit and loss, 
periodically, during the life of the bonds. But is this correct 
from a financing as well as from an accounting point of 
view ? 

When treating of investments in bonds, we have seen 
that, according to the tenets of the accountancy of invest¬ 
ment, bonds assure to their owners the return of the prin¬ 
cipal invested, and a periodical effective return of interest 
which, in the case of bonds purchased at a premium, is 
smaller than the nominal return; while in the case of bonds 
purchased at a discount it is greater. We have also seen 
that, in the case of premiums on bonds the theory which 
holds that the nominal return is income, is a fallacy, as 
evidenced by the disastrous effect that it has upon the estate 
of a remainderman under the provisions of a will directing 
the executor to invest the principal of the estate in bonds, 
to pay the interest to a life-tenant and, at his or her death, 
the principal to the remainderman. We have demonstrated 
that if the investor must make his income reflect the rate of 
interest that he expected on his investment, he must amor¬ 
tize or accumulate the cost of the investment to par through 
the Interest account. 

If the purchaser of bonds above par must reduce the cost 
of his investment by charging his income with the periodical 
amount to be amortized, why should not the vendor of the 
bonds amortize the premium which he has received, by 
crediting, not his Profit and Loss account, but his Interest 
account? Is it not true that the effect of the premium is to 


BONDED DEBT 


343 


reduce his interest charges, whereas the effect of the 
discount which he sustains when the investor obtains a dis¬ 
count, is to increase his interest charges ? 

To make this plain through an example: If the accounts 
of the investor show: 


Investment in Bonds 
5% First Mortgage Bonds 



Interest 

Principal 

Date 

Nominal 

5 % 

Effective 

4 % 

Amor¬ 

tization 

Dr. 

Cr. 

Balance 

May 1, 1914... . 
Nov. 1, 1914_ 

$1,250.00 

$ 1 , 044.91 

$205.09 

$52,245.64 

$205.09 

$52,040.55 


why should not the accounts o f the company show: 


First Mortgage 5% Bonds, 1914-1928 


1914 

May i Cash.$50,000.00 


Premium on First Mortgage 5% Bonds, 1914-1928 


1914 

1914 


Nov. 1 Interest on Bonds..$205.09 

May 1 Cash. 

.$2,245.64 

t 


Interest on Bonds 


1914 

Nov. 1 Cash .$1,250.00 


1914 

Nov. 1 Discount .$205.09 


Premiums as Deductions from Principal 

There are two more theories to be considered in con¬ 
nection with the treatment of premiums on bonds: One is 
to the effect that premiums obtained on bond issues should 


































344 THE THEORY of the liability accounts 

be set aside to serve as the nucleus of the sinking fund for 
the redemption of the principal at maturity; the other states 
that “the premium must follow the principal,” that is to say, 
must be deducted from the authorized issue. 

It will be noted that these two theories are similar in 
principle; both attempt to provide for the partial redemption 
of the debt. Logical as both may appear to their advocates, 
they fail to take into consideration the intimate relation 
which should exist at all times between the bonded debt and 
its interest cost. 

The careful student of accounting must be impressed 
with the fact that, whatever the methods of treating pre¬ 
miums and discounts may be, their ultimate result is the 
same no matter what their intent may have been. 

The theory which applies premiums and discounts as 
additions to, or deductions from, income, allows them to 
contribute to, or to reduce, the amount of net profits out of 
which a fund will be created for the redemption of the debt, 
either through the accumulation of a reserve, a fund out of 
profits, or both. 

The theory which applies premiums and discounts as de¬ 
ductions from, or additions to interest cost, has precisely the 
same effect, and the same is true of the theories which use 
premiums either as a sinking fund nucleus or as a partial re¬ 
demption of the debt. 

The great question at issue in all accounting matters is 
not, however, a question of results, but it is one of illumina¬ 
tive sub-results. It is evident that if we ignore the nominal 
accounts, and are satisfied to deduct the liabilities from the 
assets at the end of a period, and compare the result with 
that of the prior period as elucidated by a similar treatment 
of the balance sheet, we shall obtain the net profit or loss of 
the period; and nothing that we could do would change the 
result. But we have failed to show the causes which have 
brought about the result; we have also failed to show the 


BONDED DEBT 


345 


exact status of, and the relation between, the different causes. 
Lastly, we have failed to mention facts which, if known, 
and known to be true, would make it possible to pass a com¬ 
prehensive and accurate judgment upon the operations and 
the financing of the enterprise. 

Hence, throughout our accounting we must remember 
that figures which are not capable of making any statement 
of their own, and can only vouch for the accuracy of the 
final result, are meaningless and worthless. 


CHAPTER XXIX 


SECURED DEBT-UNSECURED DEBT 

SECURED DEBT 

Real Estate Mortgages 

“In equity, whatever property, real or personal, is cap¬ 
able of an absolute sale, may be the subject of a mortgage.”* 
“A mortgage may be made to cover both real and personal 
property; and the validity of a mortgage on real estate is 
not affected by the fact that it also pledges personal prop¬ 
erty and is recorded in the records of chattel mortgages.”! 
In fact, unless statutes prohibit, a mortgage may be made 
to cover not only land and buildings, but machinery, and 
even profits to arise from the operation of the said real and 
personal properties. In the state of Louisiana, where the 
Code Napoleon prevails, only “immovable” property can be 
mortgaged. 

Generally speaking, in order that a mortgage given by 
a going concern may be valid and its provisions enforced, it 
must have been given for a consideration which, in point 
of time, may be : 

1. Received at the time of the execution of the instru¬ 

ment 

2. Receivable at some future time 

3. Received at some previous time, subject to condi¬ 

tions which, being unfulfilled, are canceled in con¬ 
sideration of the mortgage 

* Wright v. Shumway, 30 Fed. Cases, No. 18,093; 1 Biss. 23-26. 

t Long v. Coclcern, 29 Ill. App. 304. 

346 




SECURED DEBT 


347 


The consideration itself may be: 

1. The receipt of property or of money or its equivalent 

2. The granting to the mortgagor of the right to en¬ 

force the mortgagee’s performance of a contract 
for future delivery of money when certain condi¬ 
tions are fulfilled by the mortgagor 

3. The extension of the time of settlement of claims 

and accounts outstanding against the mortgagor 

4. The surrender by the mortgagee of securities previ¬ 

ously pledged to him as a security for a debt of 
the mortgagor which is to be extended 

1. Receipt of Property or Money. If the consideration 
has been the receipt of property, money, or its equivalent, 
the accounting procedure necessary to express the transac¬ 
tion on the books of the mortgagor, is to record the asset 
obtained as well as the liability incurred therefor. No entry 
of any kind is made in the account recording the value of the 
asset mortgaged, since the conveyance of it is subject to a 
claim which defeats it if certain conditions are satisfied. 

2. Mortgagor’s Right to Enforce Contract. If the con¬ 
sideration has been the granting to the mortgagor of a 
financial right to be exercised at some future time, upon the 
fulfilment by him of certain conditions (such as is the case 
with building loans), the mortgagor may : 

a. Record his financial right and, correspondingly, the 

long-term liability which he has incurred and se¬ 
cured ; subsequently, when exercising his right, 
debit the asset received and correspondingly de¬ 
crease the right. 

b. Omit the recording of the right, and record the asset 

and the liability only at the time the asset is 
actually received. Of course, in this case, the 
amount of the liability recorded is precisely that 
of the asset received. 


348 THE theory of the liability accounts 

3. Extension of Time. If the consideration has been 
the extension of the time of settlement of claims and ac¬ 
counts outstanding against the mortgagor, it is necessary to 
make the books reflect the fact that the old debt has been 
canceled and that a new one, having a longer maturity, has 
been incurred. 

4. Surrender of Securities. If the consideration has 
been the surrender, by the creditor, of securities pledged to 
him in exchange for the security of the mortgage, the change 
in the nature of the liability must be recorded by canceling 
the pre-existing debt and recording the new one. 

Chattel Mortgages 

Real estate mortgages convey title to real property; 
chattel mortgages transfer title to personal property; both 
do so with a clause of defeasance, that is to say, with a 
clause to the effect that, if the giver of the security per¬ 
forms his share of the contract, the title reverts to him. It 
has been repeatedly held by courts of law that the passing of 
the title under both kinds of mortgages is merely a legal 
fiction, and that what the mortgagee really receives, is a 
lien pure and simple. 

As to the consideration for chattel mortgages, it has been 
claimed that any consideration which will support an or¬ 
dinary contract will also support a chattel mortgage. 

The covenants of both the real estate mortgage and the 
chattel mortgage, if legally enforceable, might accumulate 
the value of the asset of the mortgagee, or the extent of the 
debt of the mortgagor. If, for instance, one of the covenants 
is to the effect that the mortgagor is to pay all legal fees 
and all other costs, trouble, and expenses, the notice by the 
mortgagee of the amount expended by him must be recorded 
by the mortgagor as an increment of the debt, and by the 
mortgagee as an increase of the asset. 

The main accounting difference between real estate and 


SECURED DEBT 


349 


chattel mortgages is found in the fact that the terms of the 
former are usually of such duration as to make the debt a 
capital liability, whereas the terms of the latter, if stated, are 
usually short, and, if not stated, make the instrument pay¬ 
able on demand. 

Interest on Mortgaged Debt 

From the point of view of accounting, there is nothing 
particularly interesting in the debt incurred for interest on 
mortgages, except that, if not paid when due, it may in all 
propriety be added to the principal debt. 

Secured Debt 

The term “secured debt” is used by accountants to denote 
all liabilities, to secure which an asset has been pledged by 
transfer to the creditor. 

The word “pledge” is used here in its strictly legal sense, 
as indicating the physical transfer to the creditor of valuable 
property of the debtor, to be held until settlement by the 
pledgor, who retains title in the thing pledged. 

Debts may be secured by the pledge of bonds, stocks, 
mortgages receivable, warehouse receipts, or by the pledge 
of any personal property or evidence of the possession and 
ownership of such property. 

The pledging of bonds, stocks, or other personal prop¬ 
erty as security for debt, leaves the borrower in legal posses¬ 
sion of the pledge, but places the creditor in physical posses¬ 
sion thereof. True to the principles of law, the theory of 
accounts requires that the pledgor record his liability under 
the loan, in the amount of the asset received, and make no 
record whatsoever in the account containing the asset 
pledged by him to secure a more liquid one. 

We have already discussed at length the nature of bonds 
and stocks as assets or as liabilities. Nothing further need 
be said about them in their capacity as pledges. It may, how- 


350 THE THEORY of the liability accounts 

ever, be interesting to touch upon warehouse receipts, which 
are so often used by business houses as security for advances 
from financial institutions. 

Warehouse Receipts 

A warehouse receipt is an acknowledgment by a ware¬ 
houseman that he has received and holds in store for the 
bailor the amount and description of goods named in the 
receipt. 

At common law, warehouse receipts were not negotiable, 
although they were assignable; but since certain states have 
enacted statutes concerning these instruments, it must be 
said that they are governed by the laws of the particular 
states in which issued. 

The Uniform Warehouse Receipts Act (Par. 516) has 
this to say about this type of commercial paper: “A receipt 
in which it is stated that the goods received will be delivered 
to the depositor or to any other specified person is a non- 
negotiable receipt. A receipt in which it is stated that the 
goods received will be delivered to the bearer, or to the order 
of any person named in such receipt, is a negotiable receipt.” 

The pledging of a warehouse receipt as security for a 
loan is made valid by the mere delivery of the receipt with 
the intention to create a pledge. If the pledgor fails to 
pay his indebtedness at the appointed time, the pledgee may 
sell the property represented by the receipt, after having 
notified the. pledgor of his intention to do so. 

UNSECURED DEBT 

Notes and Bills Payable 

The status of promissory notes payable cannot be ascer¬ 
tained without a thorough knowledge of the law of com¬ 
mercial paper; the same is true of the liability account “Bills 
Payable.” 


UNSECURED DEBT 


351 


It is unquestionably true that the average keeper of ac¬ 
counts, after drawing a postdated check, will generally credit 
cash and debit the creditor’s account, precisely as if the 
check bore the date when drawn. Still, under the doctrine 
of the laws of commercial paper, a postdated check is a 
negotiable bill of exchange, payable on demand after the 
day of its date; and further, the acceptor of the check ac¬ 
cepts it precisely as he would a bill of exchange ; hence, the 
recording of a postdated check for the payment of a liability 
fails to cancel the liability; it merely transforms it into an¬ 
other, and the entry should be: 

Creditor 

To Bills Payable 

As has been said before when treating of assets, the gen¬ 
eral term “notes and bills” should be kept in separate 
accounts. 

Bills Payable 

The signature of the drawer of a bill of exchange is of 
itself a guarantee to the payee that the drawee has sufficient 
funds to meet the bill; it is also an implied guarantee that 
the drawee will accept the instrument and pay it at its 
maturity, or that, in the case of default by the drawee, the 
drawer will pay the bill. 

If, then, the drawee has funds of the drawer, the former 
must, upon acceptance of the instrument, debit the drawer 
and credit the account “Accepted Bills Payable”; the drawer, 
on the other hand, must credit the drawee and debit the 
payee. If, in contradistinction, the drawee has no funds of 
the drawer, the latter must debit the payee and credit the 
drawee, whereas the drawee must debit the drawer and 
record the liability incurred by him for the account of his 
correspondent 

If the drawee refuses to accept the bill, the drawer be¬ 
comes liable; that is to say, instead of having realized an 


352 THE theory of the liability accounts 

asset and applied it to the liquidation of a debt, he has merely 
changed the nature of his indebtedness towards the payee. 
Hence, he must reverse the entry previously made and record 
the change in the nature of the liability. 

The liability of the drawee, under the terms of a bill of 
exchange, begins only upon his acceptance of the instru¬ 
ment, and should be recorded only at that time, whereas the 
liability of the drawer, or maker, ceases upon acceptance by 
the drawee, and should be canceled at -that time, there re¬ 
maining only a contingent liability. 

Memorandum Checks 

Germane to the subject of bills of exchange, is that of 
memorandum checks. When it is desired to acknowledge a 
debt in a formal financial way, a check is sometimes drawn 
in the amount of the debt, bearing the date of maturity of the 
liability, and the word “Memorandum” written across its 
face. Such a check is not intended for immediate presenta¬ 
tion, and is in fact a bill of exchange payable on demand 
after its maturity. Of course, if the check is not postdated, 
the fact that it bears the word “Memorandum” does not 
prejudice the right of the payee to present it immediately. 

The execution of a postdated memorandum check calls 
for no special accounting record if the original debt has been 
recorded in the usual manner through the creditor’s account. 
In the contrary case, the credit may be given to the account 
“Bills Payable.” 

Promissory Notes Payable 

While the liability of the drawer of a bill of exchange is 
secondary, that of the maker of a promissory note remains 
primary; or, what is more to the point, if the note is not 
negotiable, the nature of the liability of the maker towards 
the payee has not changed in the slightest degree. Conse¬ 
quently, the transaction in virtue of which a non-negotiable 


UNSECURED DEBT 


353 


promissory note has been issued to a creditor, requires no 
recording if the maker of the instrument considers only its 
legal status. In the case of a negotiable instrument it is 
customary to cancel the original debt for which the note is 
issued, and to record the new debt in the account “Notes 
Payable.” 


*> i .. 


CHAPTER XXX 


ACCOUNTS PAYABLE—DIVIDENDS PAYABLE 
Accounts Payable Records 

Theoretically, the term “accounts payable” is a balance 
sheet term. When found in that financial statement, it may 
include: 

1. The credit balances of the accounts of creditors 

2. The amount of expense bills received at the end of 

a period, and not paid as at the date of the balance 
sheet 

3. The balances due to officers or employees of the con¬ 

cern on credit accounts which they were permitted 
to accumulate for any purpose whatsoever 

4. Unsettled claims against the concern from whatever 

sources they may originate 

5. Taxes, rentals, interest, due and unpaid at the time 

of the statement, etc., etc. 

Inasmuch as the purpose of a balance sheet is to show 
the financial status of an enterprise at some given date, it 
does not particularly matter whether or not unsecured in¬ 
debtedness is so analyzed as to show its sundry elements. 
But while the balance sheet may be permitted to speak in 
general terms, the books of account must be in a position to 
supply at all times the most minute information concerning 
financial facts. Hence, the general ledger should not be 
satisfied to gather in one account all the possibilities of un¬ 
secured accounts or claims to be paid; it should express every 

354 


DIVIDENDS PAYABLE 


355 

component individually. It ought to be possible to obtain 
from the ledger the exact significance of the classes of in¬ 
debtedness which have been incurred during the accounting 
period and remain unpaid at the end. 

That this principle of ever-ready analysis constitutes one 
of the vital desiderata of business, is evidenced by the care 
with which accountants have built up the voucher register, 
which supports in admirable detail the one ledger account 
expressive of all outstanding claims and accounts, i.e., 
“Audited Vouchers Unpaid.” The voucher register, it 
must be remembered, does not intend to supplant any par¬ 
ticular book, or to merge two or more books into one; it 
merely intends to analyze for the general ledger, and to 
present in ever-ready and concise form the analysis of, the 
liability account “Accounts Payable,” or “Audited Vouchers 
Unpaid.” 

The ledger account “Audited Vouchers Unpaid” is not 
intended to contain the liability for salaries and wages ac¬ 
crued and unpaid because not yet payable; it has nothing to 
do with accruals. It may, however, properly contain the un¬ 
settled claims for salaries and wages which, having been 
properly audited and recorded in the pay-roll book or on the 
departmental salary voucher sheets, have, for some reason or 
another, remained unpaid. The account “Audited Vouchers 
Unpaid” is made to reflect these facts by a periodical journal 
entry debiting the account “Salaries and Wages Accrued,” 
and crediting the matured liability account. 

Dividends Declared and Unpaid 

“A dividend is that portion of the profits and surplus 
funds of the corporation which has been actually set apart by 
a resolution of the board of directors, or by the shareholders 
at a corporate meeting, for distribution among the share¬ 
holders according to their respective interests, in such a 
sense as to become segregated from the property of the cor- 


356 THE theory of the liability accounts 

poration, and to become the property of the stockholders dis- 
tributively.” 1 

It must be carefully noted that only dividends declared 
make the stockholders individual creditors of the corpora¬ 
tion, and that holders of preferred and guaranteed shares of 
stock are not de facto creditors in the event that dividends 
which they had the right to expect, were not declared by the 
directors. 

It has been stated repeatedly that dividends declared and 
unpaid constitute a trust fund in the hands of the directors 
for the benefit of the stockholders, and cannot be disposed 
of otherwise than as intended, without the absolute and 
formal consent of those entitled thereto. On the other hand, 
it is true that in a famous Alabama case 2 it was held that, 
in the event of insolvency of a corporation, dividends unpaid 
became an asset of the corporation to be applied for the 
benefit of outside creditors; but such a legal doctrine is so 
entirely subversive of the care with which laws in general 
have guarded the interests of stockholders, that it may be 
challenged without fear or scruples. Indeed, in the State of 
New York it has been held that the receiver of a corpora¬ 
tion whose books show dividends declared and unpaid, can¬ 
not regard these dividends as a common debt, but must con¬ 
sider them as trust funds vested with a lien in favor of the 
stockholders. 3 

The sanctity of the dividend as a true, just, and uncan- 
celable debt of the corporation has been proclaimed em¬ 
phatically in North Carolina where the State attempted in 
vain to appropriate unpaid dividends of the North Carolina 
Railroad Company for the benefit of the State University. 

When dividends have been declared, and made payable 
at some future time, they can be rescinded only in the event 
that no knowledge of the declaration has transpired outside 


1 Cyclopedia of Law and Procedure, Vol. X, 546. 
a Curry v. Woodward, 44 Ala. 305. 

8 Matter of Le Blanc, 4 Abb. N. C. (N.Y.) 221. 



DIVIDENDS PAYABLE 


357 


of the board room. This, however, does not hold good if 
it is found that, instead of being declared out of the profits, 
dividends have actually been declared out of capital. 

If the dividends have been declared and paid illegally, it 
is also possible for the corporation to recover them from the 
stockholders if the latter knew that they were actually re¬ 
ceiving part of their capital to the prejudice of creditors of 
the corporation; but it is not possible to recover such divi¬ 
dends in the case where the stockholders were ignorant of 
conditions and received the dividends in good faith. 1 

What has been said in the foregoing applies only to the 
dividends declared by a going concern. The dividends of a 
liquidating concern are nothing more than the pro rata divi¬ 
sion of whatever is left of the assets after all the claims have 
been paid. 

The law of New York, which in this respect is typical 
of the laws of the other states, provides that dividends can 
only be declared out of surplus profits earned. In a Califor¬ 
nia case it was held that dividends cannot be declared out of 
earnings which represent interest accrued and not as yet 
receivable, even though it is certain that such interest will 
be received. 2 But it would seem that such a ruling is at 
loggerheads with the principles of accounting and with 
the rulings of the Internal Revenue Department of the 
Federal Government as to what constitutes income. 

Profits Available for Dividends 

What constitutes “profits and surplus” available for the 
declaration of dividends, will always remain one of the in¬ 
teresting topics of the science of accounting. Courts of law 
have ruled that it is perfectly proper to declare dividends 
out of profits inflated by the increase of the market value of 
assets unsold. In a decision by Justice Greenbaum 3 the 


1 McDonald v. Williams, 174 U. S. 397; 19 S. Ct. 743; 43 L. Ed. 1002. 

2 People v. San Francisco Sav. Union. 72 Cal. 199; 13 Pac. 498. 

3 N. Y. Supreme Ct.; Reported in N. Y. Law Journal, April 2, 1914. 



358 THE THEORY OF THE LIABILITY ACCOUNTS 

court said: “A corporation has a very wide discretion in 
determining when a dividend shall be made. There might 
be a difference of opinion in a given case as to the wisdom 
of accumulating a large surplus which otherwise would be 
applicable to the payment of dividends, but that would not be 
a subject for legal interference where the discretion is fairly 
exercised. If the defendant corporation has the right to 
accumulate a surplus, it has the right to invest the surplus in 
securities, and if the securities appreciate in value, there is 
no reason why the profits arising from the investment should 
not be regarded as the profits of the business of the corpora¬ 
tion.” 

The language of the courts is quite clear as to the ulti¬ 
mate disposition of increased value of securities acquired out 
of surplus. It remains to be seen, however, whether or not 
it is proper to pay dividends out of “profits” obtained by 
adding to capital assets of a physical nature, acquired to be 
used for the operating purposes of the business, favorable 
market fluctuations which cannot be realized in cash, since 
the assets are not for sale, nay, cannot be sold without bring¬ 
ing operations to a stop or to an end. 

It is quite conceivable that, in order to swell the surplus 
to a figure which will secure for it a respectable appearance 
after the declaration of dividends out of profits actually 
realized, favorable fluctuations in the market value of fixed 
assets acquired out of capital contributions, may be con¬ 
sidered. We say that it is conceivable, because of the well- 
known tendency of investors to consider the surplus of cor¬ 
porations as the most attractive item on their balance sheet, 
irrespective of the actuality and accuracy of the assets, the 
supposed value of which is exhibited by the financial state¬ 
ment. But to declare and pay a cash dividend out of such 
fluctuations when it is possible that at the time the assets are 
sold their value will be considerably less than is shown by 
the books, appears to be nothing more than paying dividends 


DIVIDENDS PAYABLE 


359 


out of anticipated profits. This is said with full knowledge 
of the fact that decisions may be found upholding the legality 
of such dividends. 

If it is really desired to give to the stockholders the 
benefit of increased market value of capital assets, it would 
be infinitely better to declare and pay a stock dividend. In 
that case, if profits eventually turned out to be losses, the 
deficiency in assets to be distributed could be charged to the 
capital stock issued under the form of dividends. 

Dividends from Income—from Increased Valuations 

That there is a marked distinction between dividends de¬ 
clared out of income and profits obtained from the actual 
financial transactions of a concern examined from the view¬ 
point of operations, and dividends declared out of profits 
obtained from the increment of invested values, is evidenced 
by the fact that in differentiating between “corpus” and 
“incorhe,” in matters affecting life-tenants and remainder¬ 
men, courts have generally decided that: 

1. Dividends, whether paid in cash or in stock, declared 

out of income and profits, are income and belong 
to the life-tenant. 

2 . Dividends, whether paid in cash or in stock, declared 

out of profits due to increased valuations, are 
principal and belong to the remaindermen. 

As an accounting proposition, proper differentiation 
should be had between the components of the surplus before 
declaration of dividends, in every instance where the capital 
stock of the concern is composed of preferred stock receiving 
a stated amount of dividends, and of common stock receiv¬ 
ing, if advisable, the balance of the profits. If the profits 
are made up of operating profits on the one hand, and of 
profits due to the sale of invested capital on the other hand, 
accounting principles would seem to require that, when about 


300 THE THEORY OF THE LIABILITY ACCOUNTS 

to pay diviaeuds, the surplus be divided into two distinct 
parts: 

x. The portion which represents operating earnings 

2. The portion which represents increments of capital 

and that, the preferred stock having received its portion of 
the operating profits, and the common stock the balance, the 
surplus component representing increments of capital be dis¬ 
tributed pro rata to both classes of stock in the ratio that 
the preferred stock bears to the common stock. 

This is precisely the view taken by the legal and account¬ 
ing advisers of the Equitable Life Assurance Society of the 
United States in the matter of an extra dividend of $80,- 
000,000 declared in January, 1914, by the Union Pacific 
Railroad Company, whose preferred stock was held in part 
by the Life Assurance Society. The surplus out of which 
this dividend was declared, was made up in part of approxi¬ 
mately $59,000,000 representing profits on sales of securi¬ 
ties of affiliated and controlled companies, and approximately 
$15,000,000 gained in the conversion of convertible bonds 
into common stock on the basis of $175 of bonds for each 
$100 of stock. In deciding against the Assurance Society, 
Justice Greenbaum of the Supreme Court appears to have 
been influenced: 

1. By the terms of the preferred stock issue which 

stated: “Such preferred stock shall be entitled in 
preference and priority over the common stock to 
dividends in each and every fiscal year, at such 
rate, not exceeding 4% per annum, payable out of 
net profits, as shall be declared by the board of 
directors. Such dividends are to be non-cumula- 
tive and the preferred stock is entitled to no other 
or further share of its profits.” 

2 . By the decision in the case of William v. Western 

Union Tel. Co. (93 N. Y. 162, 168) to the effect 


DIVIDENDS PAYABLE 


361 


that the capital stock of a corporation is the 
capital or property contributed by the stockholders 
to the extent required by its charter, and that 
“whatever property it has up to that limit must 
be regarded as its capital stock” and that any 
amount of property over that limit is surplus 
profits. 

Of course the ruling of the learned justice is the law in 
the case and will remain the law until reversed; but ac¬ 
countants may still be found who believe that the contention 
of the Equitable Life Assurance Society was remarkably true 
to principles of accounting, and exhibited the shortcomings 
of preferred stock for the benefit of future investors. 

Dividends declared on capital stock belong to the stock¬ 
holders of record on the day the corporate books are closed, 
and the right to them passes to subsequent purchasers of the 
stock only upon mutual agreement between the interested 
parties. This is particularly interesting because it is not in¬ 
frequent to find among business men the belief that “option” 
sales of shares of stock convey to the buyer of the option the 
right to dividends declared on the shares between the initial 
and the closing date of the option. 

Stock Dividends 

Stock dividends may be declared in lieu of cash dividends, 
or as a result of the receipt of property by donation, gift, 
etc., or under the form of increments in value over the 
amount paid therefor. In the first instance the term “stock 
dividend” is a misnomer; it should be “dividends paid in 
stock.” 

Accounting Treatment of Dividends 

In many European countries dividends are declared by 
the stockholders at their annual meeting. Having accepted 
the financial statements as submitted by the directors, they 


362 THE theory of the liability accounts 

vote that a certain portion of the annual profits be set aside 
for reserves, that another portion be distributed tO' those en¬ 
titled thereto, and that the remainder, if any, be transferred 
to surplus. If there are not sufficient profits from the year's 
operations for the declaration of the desired dividend, the 
surplus is drawn upon, the required amount being sent to 
the profit and loss, out of which all regular dividends are 
paid. Extra dividends are paid out of surplus. 

It is safe to say that in America the majority of the 
corporations send the annual or the semiannual balance of 
net unappropriated profits to the surplus, and declare divi¬ 
dends out of that account. The journal entry giving ex¬ 
pression on the financial books to the declaration of divi¬ 
dends is: 

Surplus (or Profit and Loss, if the 


occasion arises). 

To Dividends Payable No.... $ 


It is customary to number the dividends, giving a differ¬ 
ent series of numbers to the different classes of stock. 

Unpaid portions of dividends declared must remain a 
liability of the corporation until claimed; and if it has be¬ 
come certain that they never will be claimed, they can onlv 
return to surplus by decision of the board of directors. 





CHAPTER XXXI 


ACCRUED LIABILITIES—DEFERRED 
CREDIT ITEMS 


Accrued Liabilities 

Liabilities accrued, but not due, are recorded in order 
that the income charges which they represent may be made 
to apply to the period in which they originated. The ad¬ 
visability of entering such charges at the end of a period is 
largely dependent on the requirements of the financial state¬ 
ments to be obtained at the time. If a true financial condi¬ 
tion is to be exhibited, all accrued income charges must be 
included in the statements, as well as all accrued income 
benefits, or credits- 

What the accrued liabilities will contain, depends es¬ 
sentially upon the business conducted and upon the type 
of organization. The inclusion of taxes in this group of 
liabilities is due to the fact that, unless the theory of ac¬ 
cruals is accepted and applied to the accounting of an en¬ 
terprise, taxes are recorded when paid, and do not appear 
as a liability at any time. 

The date at which the liability for taxes arises, depends 
of necessity upon the provisions of the statutes regulating 
the imposition of taxes by the different subdivisions of the 
body politic. Generally speaking, however, an individual 
is liable for taxes on whatever taxable property he pos¬ 
sesses on the day fixed for the completion of the tax list, 
and, while agreements between parties transferring the lia¬ 
bility for taxes from one to the other may be valid as be- 

363 


364 THE THEORY of the liability accounts 

tween them, such agreements do not relieve the original 
party of his liability for its payment. 

Taxes, Licenses, Assessments, and Fees 

Taxes are contributions imposed by the body politic 
upon its citizens, for its support and their protection. 

License fees are taxes imposed on the right to conduct 
a certain business. In most states they are imposed on 
such businesses as require special inspection, control, or 
regulation. 

Assessments are charges made against property owners 
benefited by improvements made to public property, to 
defray the cost of the said improvements. Thus assess¬ 
ments partake of the nature of a consideration for the en¬ 
hanced value of the property by reason of the impro\e- 
ments made. 

Fees include all amounts paid to public officers for 
services rendered. 

Classification of Taxes 

Taxes are divided into direct and indirect. Direct taxes 
are imposed upon the individual with the intention that he 
shall pay them and bear the burden of them himself. In¬ 
direct taxes are those imposed upon property in such wise 
that they can be added to the price and so passed on to 
somebody else. More specifically, taxes may be classified 
as: 

1. Federal Taxes 

2. State Taxes 

3. Municipal Taxes 

Taxes are further subdivided as: 

1. Business and Occupation Taxes 

2. Property Taxes 

3. Excise Taxes 

4. Inheritance Taxes 


ACCRUED LIABILITIES 


36s 


1. Business Taxes 

The term “business taxes” includes all taxes which can¬ 
not be strictly construed as taxes on property, excise taxes, 
or inheritance taxes; they are, for instance: 

a. Taxes upon the premium receipts of insurance 

companies 

b. Taxes upon the gross receipts of railroad companies 

c. Taxes on savings banks according to their deposits 

“Occupation taxes’’ are in the nature of licenses to con¬ 
duct business, rather than taxation, in a strict sense of the 
term. 

2. Property Taxes 

Property taxes are subdivided into: 

a. Taxes on real property and interest thereon 

b. Taxes on personal property 

a. Taxable real property includes, generally speaking, 
whatever the individual state laws have classified as real, 
such as land and buildings and their appurtenances and im¬ 
provements; machinery and fixtures which are attached to 
the buildings in such a manner as to be part of them under 
the meaning of the law; mines, minerals, and even mining 
rights; riparian and water rights; bridges and wharves. 

b. Taxable personal property includes: money in the 
possession of the individual, or receivable by hint at the 
time of the assessment; traders’ and manufacturers’ stock 
in trade; boats and vessels; loans and investments of money; 
debts due to residents by non-residents; annuities; fran¬ 
chises, etc. 

3. Excise Taxes 

These taxes are levied on particular classes of goods, 
or commodities; the term commodities has been said by 
eminent jurists to include corporate franchises, transfers 


366 THE theory of the liability accounts 

of shares of stock, and the giving of trading stamps in 
connection with a sale of merchandise, giving right to 
goods other than the goods sold. 

4. Inheritance Taxes 

These taxes are imposed upon the privilege of acquiring 
property by inheritance, legacy, or succession; they are 
levied in accordance with the provisions of the laws of the 
individual states. The rate of the tax and the particular 
properties which will be deemed taxable, are also matters 
of state legislation. 

Deferred Credit Items 

To the average concern, the items included in this class 
of financial facts are not liabilities; they are merely (1) 
benefits received during a certain period and applicable to 
a subsequent one, as for instance: 

a. Unextinguished discounts on securities acquired 

b. Unextinguished premiums on securities issued 

c. Unearned portion of fees received in advance of 

the rendering of services 

or (2) aggregations of credits measuring the amount of 
cash receipts for the distribution of which sufficient in¬ 
formation is lacking. 

It requires no great effort of imagination to realize 
that: 

1. Discounts obtained on securities purchased or pre¬ 
miums realized on securities issued could have 
been applied to the profits of the period in which 
the purchase took place, and that it is only the 
desire to make a series of periods receive the 
benefit of the gain, which indicates the deferring 
of the application. 


DEFERRED CREDIT ITEMS 


367 

2 . Unearned portions of fees received in advance of 

the rendering of services, while, no doubt, giving 
rise to a liability for work which may, or may 
not, entail expense, do not represent a financial 
liability as we understand the term. Here, again, 
it is only the desire of being conservative and 
true to accounting principles which has demanded 
that the application of the fees to the income be 
deferred until such time as the work is done. 

3. The lack of sufficient knowledge to properly credit 

the account which brought in cash, does not give 
rise to a liability, but merely defers the time when 
the name of the outgoing value will be known. 

The rulings of the Interstate Commerce Commission 
have greatly extended the meaning of the term “deferred 
credit items” so far, at least, as public service corporations 
are concerned. This class of facts has been made to in¬ 
clude, not only benefits applicable to subsequent periods, 
unearned portions of income, and credit balances of sus¬ 
pense accounts, but, as well, operating reserves, and lia¬ 
bilities on account of provident, pension, savings, relief, and 
hospital funds, whether contributed by employees, or by the 
company, or by both, wherever such funds are managed by 
trustees for the company. 

While, at first glance, it may appear odd to include 
operating reserves among deferred credit items, it will be 
seen, when the nature of such reserves is investigated, that 
the only thing which may happen to them is to be paid out 
when the loss for which they provide has materialized. And 
since the entry giving expression to the payment of the 
reserve will be: 

Dr. Reserve — Cr. Cash 

it must be readily seen that what is actually deferred is the 
time when cash will actually go out to pay the loss. 


368 THE THEORY OF THE LIABILITY ACCOUNTS 

Operating reserves are created by charging operations 
for overcharges to passengers or shippers, and for injuries 
and claims of similar nature, which, while as yet not posi¬ 
tively determinable, are bound to occur in an amount which 
experience has established, within a series of periods. The 
reason for spreading the losses with some sort of equality 
over a series of periods instead of taking cognizance of 
them only when they materialize, is to be found in the ac¬ 
counting conviction that unless this is done, comparisons 
between the individual periods of a series will be unfair. It 
is for the very same reason that all accruals are so often 
recorded monthly. 

The reason for the inclusion of the liability for pension, 
hospital benefit, and other similar funds is to be found else¬ 
where. The Interstate Commerce Commission has so classi¬ 
fied the balance sheet of public service corporations engaged 
in the interstate traffic that it is possible to oppose: 

• 

Capital Assets to Capital Liabilities 

Working Assets to Working Liabilities 

Accrued Assets to Accrued Liabilities 

Any asset or liability which does not fit this classifica¬ 
tion is of practically no importance so far as the operations 
of the property are concerned; the assets represent nothing 
available for current purposes; the liabilities represent noth¬ 
ing which has to be met for current purposes. On the other 
hand, there is an item, “Hospital Fund,” the application of 
which is deferred, while opposed to it there is a liability the 
payment of which, out of a fund with a deferred applica¬ 
tion, is postponed until the claim is made. 


CHAPTER XXXII 


RESERVES AND SURPLUS—PROPRIETORSHIP 

ACCOUNTS 

RESERVES AND SURPLUS 

Distinction Between Reserves and Surplus 

Reserves and surplus not appropriated, together measure 
the profits made by the corporate enterprise and as yet 
undistributed. As such they constitute the increments of 
its capital not represented by shares of stock, and not ex¬ 
pressible in shares of stock except through the declaration 
of a stock dividend. 

The only real difference between reserves and surplus is 
that the former are that part of the surplus earnings which 
has been set aside to provide for losses which may or may 
not materialize; whereas the latter is that part of the sur¬ 
plus earnings which has been allowed to accumulate for dis¬ 
tribution among the stockholders in the form of dividends, 
or for such other disposition as may seem desirable. 

The foregoing applies neither to operating reserves nor 
to reserves for depreciation created by charges to cost of 
operations or to cost of goods manufactured; nor again, to 
secret reserves. Still, it might be, and has been argued that 
by reducing the profit through charges to income, these re¬ 
serves come out of surplus just as effectively as if they had 
been appropriated out of it. The truth or fallacy of this 
argument will become apparent when we have classified re¬ 
serves and analyzed the different classes. 

369 


370 THE THEORY OF THE LIABILITY ACCOUNTS 

Classification of Reserves 

Reserves are classified as follows : 

1. Reserves for Depreciation. Reserves representing 
actual losses of capital through operations, charged to opera¬ 
tions or to manufacturing cost of goods, and temporarily 
withheld from the asset account which they would reduce 
if applied to it. 

2. Operating Reserves. Reserves representing charges 
to operations for losses which have not yet materialized but 
will positively materialize. 

3. Reserves for Surplus Contingencies. Reserves repre¬ 
senting appropriations of surplus for losses that may or may 
not materialize; such reserves are: 

a. Invested in a special fund, or 

b. Not specifically invested, but contained in the general 

fund constituting the gross assets. 

4. Reserves for Redemption of Debt. Reserves repre¬ 
senting appropriations of profits, intended to reduce the 
amount of profits available for distribution, in order that 
the amount so appropriated may be compelled to remain in¬ 
vested in the business until it is time to apply it to the re¬ 
demption of debts. These reserves may be: 

a. Specifically invested in properly earmarked redemp¬ 

tion funds, or 

b. Not specifically invested. 

5. Secret Reserves. Created by: 

a. Reducing the cost or book value of certain assets 

beyond the limits of the probable or the possible, 
or 

b. Reducing both assets and profits by deducting from 

the cost of investments the income which they 
produce, or 


RESERVES AND SURFLUS 


371 


c. Applying specific or general contingency reserves to 

the reduction of assets with which they are not 

related. 

6. Reserves for Exhaustion of Physical Assets. 

Before proceeding further, it must be understood that the 
fact that an account is called “Reserve” does not necessarily 
give it the right to masquerade under that title. The lia¬ 
bility recorded for taxes accrued can no more be called a 
“reserve for taxes” than the credit offsetting a debit to an 
asset for increase of market value can be called a “reserve 
for appreciation” of that asset. Nor can the term be ap¬ 
plied to a deferred credit item such as “unearned consulting 
fees” or “unearned title fees.” 

Having classified reserves, each class must be analyzed, 
and both its purpose and the principles which is applies be 
ascertained. 

1. Reserves for Depreciation 

Depreciation is composed of two distinct elements: 

a. The irreparable loss suffered by the physical unit 

through: 

(1) Wear and tear caused by operations 

(2) Accidents 

(3) Efflux of time 

(4) Mere exposure to the elements 

b. Obsolescence of the type 

Whenever, through operation or accidental causes, a 
physical unit has sustained a loss of efficiency incapable of 
being restored by adequate repairs, there is supposed to re¬ 
main an element of loss which, intangible as it may be, has 
partially consumed the capital invested in the unit; and as 
years go by, the succession of injuries to the unit reduce it 
to a level of efficiency so low as to make the asset of very 
little value from a practical standpoint. Thus, elements 1, 


2^2 THE THEORY OF THE LIABILITY ACCOUNTS 

2, and 3 are so closely related, and so undeniably associated 
with operations, that it has been deemed quite proper to 
charge the depreciation loss which they indicate, to the cost 
of the goods manufactured, or, if the concern is not manu¬ 
facturing, to the cost of conducting the enterprise. 

As to the loss due to exposure to the elements, it may 
properly be argued that it has little, if anything, to do with 
operations. It is, besides, so difficult to estimate properly the 
loss sustained, that it would seem impossible to provide for 
it otherwise than by application of surplus, subject to adjust¬ 
ments whenever the exact truth becomes known. 

Obsolescence of type represents a loss only when known. 
Provision for this loss far ahead of its materialization is 
one of the many precautions dictated by conservatism, which 
must be reckoned with. But it is a complete denial of its 
purpose, to treat it indifferently, and sink it, merged with 
other elements of depreciation, in the cost of operations. If 
there is ever a good reason for creating a specific re¬ 
serve out of net profits, that reason is presented by the 
possible obsolescence of physical units. It may be feared 
that a specially made machine will be rendered useless within 
a year or two or five years, by the invention of a better and 
more economical machine; but the expected loss may never 
come, or may be postponed for many years. Hence, logic 
would indicate a special treatment for a special condition. 

It has, unhappily, become the usual practice to consider 
the term “depreciation” as a convenient invention for as¬ 
similating antagonistic factors; charges made to operations 
under the title of “depreciation” often contain, if the truth 
were known, provisions for unknown quantities, the ulti¬ 
mate result being the perversion of accounting truth. The 
main trouble with such unscientific accounting is that it 
works at cross purposes with the legitimate, although idealis¬ 
tic, aspirations of cost finding. It denies that an accounting 
statement of facts should be truly analytical, and should at 



RESERVES AND SURPLUS 


373 

all times “split hairs,” if necessary, in order that conclusions 
to be made from figures submitted, may be minutely ac¬ 
curate instead of superficially just. 

Coming back to accounting principles, if depreciation, in 
the accepted sense of the term today, is charged to cost of 
operations, it cannot be denied that it represents a genuine 
loss through such operations. Hence, the creation of a re¬ 
serve for this loss is tantamount to merely deferring the 
time when the loss will be credited to the asset which has 
sustained it. As a consequence, a reserve for depreciation 
created in this fashion is not, and cannot be said to be, ap¬ 
propriated surplus; it cannot be shown on the liability side 
of the balance sheet, but must be deducted from the asset in 
order that the true remainder value of the asset may be 
stated. We will discuss later the different methods of pro¬ 
viding for depreciation. 

2. Operating Reserves 

Operating reserves are not appropriations of surplus; 
they measure the amount of all additional cost of operations 
which, while not necessarily incurred at the present time, 
will positively be incurred if past experience counts for any¬ 
thing; they represent cost incurred and unpaid, and the 
only connection that they can possibly have with surplus is 
that, if unnecessarily high, they will be sent in part to the 
credit of that account, in order to remove any prejudice that 
it has suffered through over-conservatism. But, until they 
are found untrue they are supposed to represent true cost, 
and cannot be stated otherwise than as items the ultimate 
disposition of which is deferred. 

3. Reserves for Surplus Contingencies 

When closing the books for the purpose of ascertaining 
the surplus profits of a period, it is customary to take as 
profits the net fluctuations of assets, representing the amount 


37 4 THE THEORY OF THE LIABILITY ACCOUNTS 

by which incoming values have exceeded the outgoing values. 
Thus, the increase of incoming claims upon customers, over 
the cost of outgoing merchandise, is taken as the gross 
profit. But it may happen that in the following period, ac¬ 
counts receivable may be lost through the failure, the lack 
of good faith, or the financial embarrassment of one or more 
customers. The account being lost, it remains to charge it 
to accumulated profits, under the form of surplus adjust¬ 
ment, in the amount of: 

a. The capital lost 

b. Profit taken as such during the prior period, and 

lost during the present one 

But, since losses of accounts receivable are likely to be 
sustained, it is advisable at the end of any given period to 
provide for them by appropriating enough of the very profits 
which the account brought about; which reserve must con¬ 
tain not only its quota of the profits which may be 
lost, but, as well, its quota of the capital which is likely to 
vanish. 

All reserves for surplus contingencies, to be truly re¬ 
serves, must provide either for possible losses of capital, or 
for possible losses of accumulated surplus. If they are for 
contingencies of an unknown nature, as, for instance, a sort 
of insurance against problematic financial happenings, they 
are not truly reserves; they are surplus temporarily debarred 
from dividend distribution. 

4. Reserves for Redemption of Debt 

It is a well-established principle of finance that debts in¬ 
curred to obtain at once a large amount of capital required 
for improvements or additions which will increase earning 
power, should be repaid out of profits. 

If, for instance, an individual borrows $20,000 to estab- 


RESERVES AND SURPLUS 


375 

lish a stage line between two towns, it must be that he has 
in view: 

a. To obtain the necessary equipment out of money 

which he does not own, and which represents the 

wealth of somebody else 

b. To obtain out of that equipment an income which his 

business acumen tells him will be large enough to: 

(1) Meet the charges for interest which the 

lender of the capital will make. 

(2) Give him, the borrower, enough of a re¬ 

mainder to: 

(a) Live from the fruit of his industry 

(b) Maintain the property acquired out of 

the money borrowed 

(c) Provide for the natural exhaustion of 

the property 

(d) Repay the original debt 

If he has, perhaps, been able to persuade the lender to 
accept the equipment in payment of the debt at maturity, he 
must have in mind to set aside annually out of his income, 
enough money to either pay the loan or supply him with 
the capital necessary to acquire new equipment. If neither 
of these two propositions fits in with his purpose, he will, 
at maturity of the debt, lose both the equipment and the 
income. 

If a railroad company possessing a one-track line, and 
believing that a two-track line will double its income, bor¬ 
rows enough money to proceed immediately with the im¬ 
provement, instead of proceeding gradually by reinvesting 
in property the profits obtained from the original investment, 
it must be that it intends to repay the debt out of profits. If 
this is not the case, how will the debt be repaid ? Through 
the sacrifice of the assets originally obtained out of contri¬ 
butions of capital ? By giving back that part of the capital 


376 THE theory of the liability accounts 

assets obtained out of the debt incurred? If the former 
method is adopted, what sense was there in the exchange? 
If the latter, what sense was there in borrowing? The bond¬ 
holders must expect their bonds to be paid out of profits and 
not out of the very capital which their money has pur¬ 
chased, since that capital is pledged to them as security; 
they cannot expect to be paid out of the capital acquired 
through antecedent liabilities incurred, since that capital is 
pledged to others. 

Hence, reserves for the redemption of debts must be 
created out of profits. It is evident, however, that if suffi¬ 
cient profits are not reserved and so earmarked that it will 
be at all times possible to identify them, their purpose may 
fail; if they remain in the free surplus they may be dis¬ 
tributed as dividends, and there will be left to pay the debt 
nothing but the pledge more or less depreciated, the sale of 
which will deprive the borrower of the very asset for the 
acquisition of which he contracted a liability. 

Since reserves for redemption of debts must be created 
out of profits, it is possible: 

a. To appropriate surplus earnings as measured by the 

Surplus account, or by the periodical profit and 
loss. This appropriation prevents the distribu¬ 
tion, under the form of dividends, of assets repre¬ 
senting reinvested profits. 

b. To set aside the assets themselves by taking them 

out of the general fund of assets, and assigning 
them to a sinking or redemption fund. 

In the former case we have a reserve for the redemption 
of a debt; in the latter case we have a sinking or a redemp¬ 
tion fund. Either of these two methods is adequate of 
itself; if the two are used in conjunction, no particular 
purpose is accomplished, but scrupulous conservatism is 
satisfied. 


RESERVES AND SURPLUS 


377 


5. Secret Reserves 

This accounting term has been made to cover a multitude 
of sins; whenever objection is taken to pessimistic writing 
off of invested values, or to disproportionate charges for 
depreciation, or again to charges to operations or revenue, 
for capital expenditures which should have been applied to 
the increase of assets, the answer is, “Secret Reserves.” A 
manufacturer of prominence in the City of New York once 
stated to the writer, in a tone indicative of deep-rooted pride, 
that his capital assets had been “bodily knocked down into 
the pit of secret reserves,” and that their book value, as it 
stood at the time, was preposterous. Since the said manu¬ 
facturer was the president of a corporation, the questions 
at issue were: Did he want to deceive the stockholders, the 
government, the public, or himself? Did he wish to sub¬ 
mit to the directors, the stockholders, the banks, and the 
public, financial statements with a mental footnote to the 
effect that things were not in truth what they showed on 
their face? And if he took the ground that it is well to hide 
your wealth from some people, did he believe that anyone 
capable of reading balance sheets is not in a position to 
follow accounting facts from year to year, and to point out 
fluctuations in wealth not supported by the statement of in¬ 
come submitted, and thus unearth secret reserves ? 

6. Reserves for Exhaustion of Physical Assets 

Certain physical assets contribute directly to the produc¬ 
tion of wealth, and others, indirectly. In the former group 
we find, mines, timber lands, etc., and in the latter group, 
plant, machinery, tools, etc. The second group depreciates 
in value through wear and tear; while the first becomes 
gradually exhausted as it yields its wealth. 

Since it is undeniable that the extraction of a ton of ore 
has exhausted the mine in the amount of the cost of that 
ton, it is evident that the investors must be made to realize 


378 THE THEORY of the liability accounts 

that all returns to them in the form of dividends contain, 
besides a share of profits, a partial repayment of capital; 
unless there has been appropriated out of the profits realized 
on the sale of the ore, enough to provide for the repayment 
of the capital when the physical assets are exhausted. 

The foregoing principles apply equally as well to the 
exhaustion of timber lands and of any other wealth-pro¬ 
ducing physical asset the life of which is dependent upon its 
exploitation. 

Creation of Reserves 

As suggested in the foregoing, reserves taken as a class 
of items, are created by charges to cost of operations, to net 
profits of the present period, or to accumulated profits of 
prior periods, and by corresponding credits to individual re¬ 
serve accounts, or to classes of reserves; but the provision 
which they attempt to make for losses of assets is just as 
effectively made by crediting the physical assets, whenever 
the loss is so positive as to be taken as cost of operations. In 
such cases, if a reserve is set up, it is only because of a de¬ 
sire to leave the original cost of the asset undistributed on 
one side of the scale, and to place on the other side a countei- 
weight, establishing the difference between the two. 

Provision for Depreciation 

To provide for depreciation of physical assets so that they 
may be gradually brought down to zero, or to their residual 
value, several methods are available: 

i. If the credit is to be given to the asset: 

a. Divide the amount to be written down into equal 
sums, each representing the loss sustained in each 
successive period of the life of the asset, and pro- ' 
vide for each such sum in due time. 


RESERVES AND SURPLUS 


379 


b. Write off periodically a sum representing a fixed per 

cent of the residual value of the asset at the be¬ 
ginning of that period. 

c. Debit the asset periodically (and credit income) 

with the interest, at an agreed rate, on the amount 
of the capital invested in the asset at the begin¬ 
ning of the period, and write off periodically the 
proper instalment of an annuity so calculated as 
to decrease the asset to zero, or to its residual 
value at the end of its effective life. 

d. Revalue the asset at the end of each period, and write 

off the periodic decrease in value. 

2. If the credit is to be given to a reserve account, the 
methods are precisely the same with the exception that 
method “b” can be operated only by obtaining the residual 
cost by means of periodically comparing the amount of the 
reserve with the original cost of the asset. 

The comparative value of the above methods need not be 
discussed at length. They all aim at the equalization of 
profits by making each successive operating period bear its 
share of the loss of capital assets. It must be stated, how¬ 
ever, that under the requirements of the Interstate Com¬ 
merce Commission the corporations subject to its accounting 
control use the first, that is to say, the simplest, method. 
Mr. Hatfield* states that the second method “involves a com¬ 
plicated mathematical calculation, and the annual rate of de¬ 
preciation gives little indication to the ordinary man of the 
period required to write off the asset. Furthermore, it in¬ 
creases the depreciation charge in the earlier years, and in 
the case of a new concern this may be distasteful as being 
an additional charge against profits at a time when business 
has not come into full swing, and profits are low.” 

The third method must be especially distasteful to ac- 


* “Modern Accounting,” page 130. 



^80 THE THEORY of the liability accounts 

v; 

countants who do not believe that interest on invested capital 
can ever be a charge either to operations or to assets, or a 
credit to income or profits. 

The fourth method would appear to offer the ideal solu¬ 
tion of a difficult problem if it were not that it is im¬ 
practicable so far as the average enterprise of any size is 
concerned. Also, this method is open to the objection that, 
while an appraisement at the end of, say, the twentieth year 
might show the asset to have a relatively large salable value, 
its real value to the enterprise, so far as efficiency is con¬ 
cerned, might be insignificant. 

Provision for Exhaustion 

The method of estimating the provision to be made for 
the exhaustion of mines, is a little simpler in theory than the 
creation of reserves, but a great deal more complicated in 
actual practice. 

Theoretically, it is plain that, while the lifting to the 
surface of a ton of ore has exhausted the vein to the benefit 
of the storeroom or the ore pile, it is only the sale of that ton 
which depletes the wealth of the mine. Hence, it seems that, 
if provision is made for the exhaustion of the prdperty, it 
should be made only on the basis of the tonnage sold. As to 
the amount to be set aside out of the profits on each ton, it 
should be such as to amount eventually, together with the 
residual value of such other assets as were acquired out of 
capital contributions, to the amount of the paid-up capital. 

PROPRIETORSHIP ACCOUNTS 

Positive and Negative Components 

The sum of the assets, less the sum of the liabilities, gives 
the amount of the proprietor’s equity in his assets. It fol¬ 
lows that every account which appears on the books after the 
closing of the nominal accounts reflecting the causes of the 
fluctuation of values, and which can be called neither an asset 


PROPRIETORSHIP ACCOUNTS 


381 


nor a liability, must be either a positive or a negative com¬ 
ponent of the equity. It also follows that, when speaking of 
the proprietor’s equity in such terms as “positive” and “neg¬ 
ative,” we must apply the former term to credit components, 
and the latter to debit components; whereas, when speaking 
of assets and liabilities, we apply the term “positive values” 
to debits, and the term “negative values” to credits. 

The components of the equity of the sole proprietor of a 
business, are: 

Negative Positive 

Deferred Debit Items Deferred Credit Items 

Drawing Account Undivided Profits 

Capital Account 

The components of the equity of the copartners are: 

Negative Positive 

Deferred Debit Items Deferred Credit Items 

Drawing Account (Debit Drawing Account (Credit 

Balance) Balance) 

Undivided Profits 

Drawing Accounts 

The theory of the drawing account of the sole proprietor 
is as follows: 

It must contain, on the credit side, the profits realized 
during the period, and, on the debit side, the drawings in 
anticipation of such profits; if capital is withdrawn, the 
amount of the withdrawal should be charged to the capital 
account. The balance of the drawing account should repre¬ 
sent the amount by which the profits have exceeded the 
drawings thereof, or the amount by which the drawings 
have exceeded the anticipated profits; when established, the 
balance should be closed to the credit or to the debit of the 
proprietor’s capital account. 


382 THE theory of the liability accounts 

The theory of the drawing account of copartners is as 
follows: 

Partners may draw, according to their articles of co¬ 
partnership : 

1. In anticipation of profits 

2. For bonuses, salaries, emoluments, etc., accruing to 

them periodically 

3. Capital 

Drawings of capital should be charged to the capital ac¬ 
count; drawings of bonuses, salaries, and so forth, should 
be charged to special credit accounts bearing appropriate 
names and created when the right to draw has matured. 
These special accounts, when created or increased by subse¬ 
quent credits, constitute liabilities of the copartnership, and 
should not be credited to the drawing account, which is to 
reflect only the extent of the drawings in anticipation of 
profits. The drawing account proper is credited with the 
profits when ascertained, and debited with drawings when 
made. The balance of the account, if a credit balance, 
should, according to the spirit of the articles of copartner¬ 
ship, be sent to the credit of the capital account, or to a 
“Loan Payable” account; or they should remain in the draw¬ 
ing account itself, subject to the pleasure of the partner. 
These credit balances are not to be treated as loans to the 
copartnership unless it is so understood among the partners. 

“Unapplied profits” are nothing more than the balance of 
the profit and loss, the ultimate disposition of which is un¬ 
certain. It may be withdrawn by the proprietor or he may 
reinvest it. In the latter case it will, in due course, be sent 
to his capital account. 

“Undivided profits” when found in the accounts of co¬ 
partners, indicate that while the profits are to be ascertained 
monthly, quarterly, or semiannually, they are to be divided 
among the partners at certain stated periods only. 


PROPRIETORSHIP ACCOUNTS 



The capital account, when analyzed, must give the fol¬ 
lowing components: 


Negative 

1. Original Liabilities 

2 . Net periodical excess of 

decreases of assets, plus 
increases of liabilities 
over increases of assets, 
plus decreases of lia¬ 
bilities, after addition 
thereto of drawings of 
anticipated profits 


Positive 

1. Original Assets 

2. Net periodical excess of 

increases of assets, plus 
decreases of liabilities 
over decreases of as¬ 
sets, plus increases of 
liabilities, after deduc¬ 
tion of drawings of an¬ 
ticipated profits in an 
amount smaller than 
the profits 


Part V—Financial Statements 


CHAPTER XXXIII 

FINANCIAL STATEMENTS BASED ON SINGLE 

ENTRY 

The Statement of Assets and Liabilities 

The theory and the mechanism of this statement have 
been treated in detail in the discussion of single entry.* 
No further comments are at present necessary, except to 
point out that the statement has a twofold purpose, in that 
it attempts to show the financial status by means of inven¬ 
tories, and to marshal fluctuations of invested values in order 
that their meaning may be clearly expressed by the state¬ 
ment of resources and of their application. 

The Statement of Resources and of Their Application 

This statement is based not only upon accounting prin¬ 
ciples but, as well, upon a principle of economics. For every¬ 
thing which one receives, one has to give up something 
already in possession, either in the line of wealth or in the 
line of credit. If this is not the case, the recipient must 
have been the beneficiary of a gift, a legacy, a bequest, or a 
devise. 

Recognizing this principle, and applying it to the busi¬ 
ness concern, the statement of resources claims that re¬ 
sources include, assets once held but now consumed; credit 


* See Chapter V. 


384 




STATEMENTS BASED ON SINGLE ENTRY 385 

once enjoyed but now partially exhausted through usage; 
and increases of wealth reinvested. 

If an individual has $100 in the bank, he has an asset; 
if he draws $25 for a suit of clothes, he turns part of his 
asset into a resource which he applies to the acquisition of an 
asset of a different nature. If, instead of consuming his 
asset, he acquires the suit of clothes upon a promise to pay 
in the future, he has turned his credit into a resource which 
he has applied to the acquisition of an asset which he did not 
possess at the beginning of the period; but he has partially 
consumed his credit, and to reestablish it, he will have to 
consume his asset “cash.” 

If a business concern has obtained, at the end of a period: 

1. New assets that it did not have at the beginning 

2. Increases of assets held at the beginning 

3. Decreases of liabilities liening the assets at the 

beginning 

it must have consumed: 

1. Certain assets held at the beginning 

2. A certain amount of its credit 

And if the aggregate of the things obtained has been greater 
than the aggregate of the consumption of assets and credit 
owned and enjoyed at the beginning of the period, there 
must have been received during the period, profits which 
have also been applied to the acquisition of wealth. 

To illustrate the foregoing, there will be demonstrated 
one of the practical problems of the New York C. P. A. 
examination of January, 1912. 

Problem 

The following is a comparative balance sheet at Decem¬ 
ber 31, 1910, and at December 31, 1911, presented to the 
directors of the Western Company at their meeting of Jan¬ 
uary 5, 1912: 


386 


FINANCIAL STATEMENTS 


Assets 


Land. 

Buildings. 

Machinery and Tools. 

Horse, Wagon, and Harness. 

Patents. 

Good-Will. 

Cash. 

Accounts Receivable. 

Investments—Bonds . 

Inventory of Goods in Process. 

Inventory of Materials and Supplies 
Agency Investment. 


Liabilities 

Bond and Mortgage Payable, 1915.. 

Notes Payable. 

Accounts Payable. 

Reserves for Depreciation. 

Discount on Bonds... 

Capital Stock: 

Preferred. 

Common . 

Surplus . 


12/31/1910 

12/31/1911 

$20,000 

$25,000* 

45,000 

45,000 

86,000 

89,000 

10,500 

10,500 

6,000 

6,000 

25,000 

25,000 

28,300 

10,300 

29,600 

26,550 


15,000 

10,800 

14,690 

6,750 

10,300 


3 >680 

$267,950 

$281,020 


12/31/1910 

12/31/1911 

$20,000 

$35,000 

2,000 

16,400 

19,350 

2,500 

6,750 


1,000 

150,000 

150,000 

50,000 

50,000 

14,050 

31,920 

$267,950 

$281,020 


* Increase due to appraisal based on rise in values of factory sites in 
vicinity. 


the immediate 


Together with the above balance sheet, there was sub¬ 
mitted to the board of directors a statement of income and 
profit and loss showing the profits of the year 1911 to have 
been $22,120. The directors state to the auditor that, in 
view of the decrease of cash and of the increase of capital 
liabilities, they are unable to ascertain what has become of 
the increased profits of the year. The auditor prepares and 


































STATEMENTS BASED ON SINGLE ENTRY 387 

submits to the directors, before the meeting is adjourned, an 
account properly named, which is so arranged as to show 
clearly how the Western Company has applied such re¬ 
sources of the year 1910 as have been lost in 1911, and the 
resources and profits of the year 1911. 

Prepare the account rendered by the auditor. 

Solution 

It is presumed that, for the enlightenment of the direc¬ 
tors, the comparative balance sheet submitted to them ex¬ 
hibited the increases and decreases of the present period over 
the last period. At all events, they must be obtained before 
the statement of resources can be established. This done, the 
factors which have contributed to the increase of wealth 
(i.e., increases of assets and decreases of liabilities) and the 
factors which have contributed to the decrease of wealth 
(i.e., decreases of assets and increases of liabilities) are op¬ 
posed as shown on page 388. 

It will be noted that the $15,000 increase of assets rep¬ 
resented by the account “Investments in Bonds,” has only 
consumed $14,000 of other assets, since it has been acquired 
at a discount of $1,000, and that only the actual cost can be 
employed to represent an asset consumed to acquire another; 
that the profits reinvested are not the amount shown by the 
statement of income, but are only part of the total profits 
which were actually received; in other words, since only 
$21,050 of the assets of the prior period and $22,950 of 
credit of the prior period have been consumed to acquire 
$28,120 of new assets and to rehabilitate the concern’s 
credit in the amount of $33,000, the excess of applications 
over the consumption of resources must have been produced 
by such profits as were actually received in cash. 

If the consumption of resources represented by decreases 
of assets and increases of liabilities is greater than the ap- 


3 88 


FINANCIAL STATEMENTS 


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STATEMENTS BASED ON SINGLE ENTRY 389 

plication, the statement will end on the credit side as 
follows: 

“To pay for the cost of conducting the business, over 
and above the return thereof in the line of profits,” or some 
such appropriate explanation. 

* / 

Proof of Ledger Assets 

The Insurance Department of the State of New York re¬ 
quires insurance companies to submit a statement calling 
for: 


1. Amount of ledger assets at beginning of 


the year. $ 

2. Income of the year. 


Total. $ 

3. Disbursements of the year. 


Balance—representing assets at the end 
of the year. $ 


Recognizing the principles of accounting supporting the 
insurance statement, the New York Board of C. P. A. Ex¬ 
aminers applied these same principles to a mercantile busi¬ 
ness, and built up an examination problem in June, 1912, 
which was severely criticized by accountants who claimed 
that it was impossible to start with the amount of assets 
at the beginning of the period, add the income, deduct cash 
disbursements, and arrive at the assets at the end. 

The criticism is based on sandy foundations. In account¬ 
ing parlance, the word “disbursements” applies to cash, only 
if it is qualified as “cash disbursements.” Speaking from 
the broad point of view of principles of accounting, an asset 
consumed is an asset disbursed, while cash disbursed to 
acquire another asset is not a disbursement of an asset, but 














390 


FINANCIAL STATEMENTS 


merely reflects an exchange. To illustrate the foregoing, 
there is submitted a problem which is modeled upon the lines 
of the New York C. P. A. problem referred to; it appears to 
have, over its predecessor, the advantage of presenting the 
problematic requirements in a more lucid manner. 

Problem 

The ledger of the Secaucus Supply Company shows at 
January i, 1914: 

Debits: 

Land and Buildings, $30,500; Delivery Equipment, 
$5,000; Investment Bonds, $9,500; Inventory Mer¬ 
chandise, $12,000; Stable Supplies, $150; Cash, 
$16,500; Accounts Receivable, $14,800. 

Credits: 

Accounts Payable, $9,000; Surplus, $17,450; Mortgage 
Payable, $12,000; Capital Stock, $50,000, 

The books show at June 30, 1914: 

Cash Book: 

Capital Stock, $5,000; Customers, $35,000; Interest 
on Investments, $400; Interest on Bank Balances, 
$80; Mortgage Payable reduced, $3,500; Creditors, 
$20,000; Delivery Equipment, $300; Freight, $425; 
Stable Supplies, $200; Salaries of Salesmen, $1,500; 
Advertising, $50; Administrative Expense, $6,500; 
Interest on Mortgage, $150. 

Profit and Loss Account: 

Debits: 

Purchases, $20,000; Freight outward and inward, 
$425; Stable Supplies, $235; Salaries of Sales¬ 
men, $1,575; Advertising, $50; Administrative 
Expense, $6,500; Interest on Mortgage, $210. 


STATEMENTS BASED ON SINGLE ENTRY ^91 
Credits: 

Interest on Investments, $490; Interest on Bank Bal¬ 
ance, $80; Sales, $38,500Increase of Merchan¬ 
dise Inventory, $500. 

Required: 

1. A statement which will give full expression to the 

following formula: 

“Initial Assets” plus “Income of the Period” less 
“Disbursements of the Period” equal “Assets 
at the Close of the Period.” 

2. The balance sheet of the company at June 30, 1914, 

supporting the total of the assets shown by state¬ 
ment 1. 

Note: The accounting period extends from January 1, 
1914, to June 30, 1914. 

In connection with the solution of this problem—which 
appears on the pages immediately following—it is pointed 
out: 

1. That the sale of the capital stock in the amount of 

$5,000 has increased the asset “cash,” not through 
the channel of income, but through the incurrence 
of a liability to stockholders. 

2. That adding the amount received from capital con¬ 

tributions to the original assets, we obtain the 
total amount of assets with which the concern 
started, and the addition thereto through sources 
not directly connected with income. 

3. That if we add to this total of assets, all the income 

of the period, whether received or accrued, we 
have taken cognizance of all the positive fluctua¬ 
tions of the assets, and that the result of the addi- 


Proof of Ledger Assets 

I. Capital: 

Capital Stock Outstanding... $55,000.00 




392 


FINANCIAL STATEMENTS 


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Total Assets.$100,660.00 I Total Liabilities and Surplus.$100,660.00 































FINANCIAL STATEMENTS 

tion would be the amount of the concern’s assets 
if it had cost nothing- to obtain the income. 

That the cost of obtaining income can only be that 
which has consumed assets, and must exclude that 
which has brought about the recording of an ac¬ 
crued liability. 

To make this still clearer: 

Stable supplies show at the beginning of the 


period a value of. $150.00 

During the period there have been purchased 

for cash. 200.00 

Total. $350.00 

There has been charged to profit and loss, as 

expended . 235.00 

Leaving a remainder of. $115.00 


Hence, the disbursement of the asset has been not $200 
disbursed in cash, but that amount plus $35 of the 
original asset held at the beginning of the period, and 
now consumed. 

An essential principle to be borne in mind when pre¬ 
paring this statement, is that all the accruals of income 
credits must be considered, since they affect the assets; 
whereas all the accruals of income debits must be ignored, 
since they only affect liabilities. Consider, for instance, the 
salaries of the salesmen: $1,500 was paid in cash, while 
$ 1 ,575 was charged to profit and loss; the only part of 
the expense which affected assets is the part paid in cash; 
hence, it is the only one of which the statement takes 
cognizance. 

The first and second statements discussed above are said 
to be based on single entry, because they can be established 
from books kept in accordance with the principles of that 
method of bookkeeping which recognizes only inventories 


394 


4 - 









395 


STATEMENTS BASED ON SINGLE ENTRY 

I 

of assets and liabilities revealing increases and decreases, 
without regard to the causes which brought about the fluctu¬ 
ations. As to the third, it is based on the same principles, 
since it considers only increases and decreases of assets with¬ 
out regard to the nature of the bookkeeping entries which 
gave expression to their counterpart. 


CHAPTER XXXIV 


TRIAL BALANCE—WORKING BALANCE SHEET 
Trial Balance 

The trial balance is not a financial statement; it is 
merely a list of the balances of the accounts remaining open 
on a double-entry ledger at sundry times, i.e.: 

1. After the posting of the transactions of the month, 

as reflected by the books of original entry. 

2. After the posting of the accruals and of the in¬ 

ventories, and the possible adjustment of accounts, 
due to a desire for more accurate or more exten¬ 
sive distribution. 

3. After the posting of the closing entries which estab¬ 

lish the profit and loss account and either leave it 
as it then stands, until the directors have passed 
upon its disposition, or send it to the credit of the 
accounts entitled thereto. 

The trial balance, in fact, is nothing more than a surface 
indication that the books are in balance, and that the trans¬ 
actions have been accurately recorded. 

Classified Trial Balance, or Working Balance Sheet 

Here again we have a statement which cannot be called 
financial; it leads to the establishment of the balance sheet 
and of the statement of income and profit and loss by means 
of the following process: 

1. It classifies the trial balance so as to gather, either 
on separate sheets, or on the opposite sides of a sheet divided 

396 


TRIAL BALANCE—WORKING BALANCE SHEET 

in the middle, real accounts, accounts partially real and 
partially nominal, and nominal accounts having a debit 
balance; liabilities, surplus, components, free or appro¬ 
priated, and nominal accounts having a credit balance. 

2. It provides for journal adjustments, debits, and 
credits, necessary to apply inventories or to redistribute 
certain items. 

3. It classifies the resulting figures as between: 

a. Income debits and assets 

b. Income credits and liabilities 

In fact, it aims at the presentation of a picture of a gen¬ 
eral ledger subdivided into the assets and liabilities section, 
and the income section. When completed, its accuracy is 
determined by: 

1. Adding together the trial balance debits and the 

debit journal adjustments, and deducting from the 
total thus obtained the credit journal adjustments, 
and comparing the remainder with the total of the 
assets and of the income debits. 

2. Adding together the trial balance credits and the 

credit journal adjustments, and deducting from 
the total thus obtained the debit journal adjust¬ 
ments, and comparing the remainder with the 
total of the liabilities and of the income credits. 

The working balance sheet as described is frequently 
used by accountants who, having to establish financial state¬ 
ments within a stated period, find the general ledger in¬ 
complete, improperly kept, or grossly inaccurate. They take 
as a starting point a trial balance the exactness of which has 
been established, gather the facts of the subsequent period 
from the books of original entry, journalize the results, 
and post them on the working sheet, which is thus raised to 
the dignity of a ledger. 


39« 


FINANCIAL STATEMENTS 


The handling of the working balance sheet is at no time 
difficult; however, it cannot be used successfully by anyone 
not thoroughly familiar with the mechanism of ledger ac¬ 
counts. To illustrate this point, let us attempt to use the 
sheet described in the foregoing, for the solution of a New 
York C. P. A. examination problem. 

Problem 

(New York C. P. A. Examination, June 30, 1912)* 

The following balances are taken from the books of the 
Roberts Manufacturing Co. of New York City, on the 31st 


of December, 1910: 

Inventory of Finished Goods (Jan. 1). $3,684.57 

Inventory of Raw Materials (Jan. 1). 11,392.70 

Purchases of Raw Materials. 62,519.85 

Sales . 217,387.42 

Wages . 109,317.88 

* Rent . 19,500.00 

Discounts Received on Purchases. 375.60 

Discounts Allowed on Sales. 186.36 

Power, Light, and Heat. 8,710.64 

Light and Heat for Office. 168.00 

Repairs . 1,090.00 

Packing . 2,017.00 

Factory Expense. 3.270.00 

General Expense. 5,230.00 

Factory Insurance. 1,050.00 

General Insurance. 750.00 

Machinery and Plant. 12,350.00 

Tools . 2,600.00 

Commissions . 7,642.00 

Office Salaries. 9,700.00 

Salesmen’s Salaries. 8,930.00 

Interest on Loans. 440.00 

Loans Payable. 22,000.00 

Discount Lost... 120.00 

Notes Receivable. 130,000.00 

Notes Receivable, Discounted. 8,000.00 

* Notes Payable. 19,500.00 


* Certain of the requirements of this problem have been omitted, as having no 
connection with the purpose of the illustration. 






























TRIAL BALANCE—WORKING BALANCE SHEET 


399 


Accounts Receivable. 

Accounts Payable. 

Office Furniture. 

Furniture and Fixtures. 

Cash on Hand. 

Cash in Banks. 

Returned Sales. 

Capital Stock. 

Reserve for Depreciation. 

Reserve for Bad Debts. 

Freight and Cartage Inward. 

Stable Expenses. 

Horses, Wagons and Harness 

Postage and Expressage. 

Superintendence . 

Taxes . 

Good-Will . 

/ 

Stationery and Printing. 

Advertising . 

Surplus (1909). 


101,026.00 

30,020.00 

1,100.00 

1,950.00 

1,825.00 

26,467.00 

276.00 

200,000.00 

3,236.98 

5,727.00 

727.00 

2,750.00 

8,500.00 

1,250.00 

3,500.00 

250.00 

10,000.00 

1,080.00 

8,630.00 

63,753-00 


1. Prepare from the above a trial balance arranged in 
systematic order, so as to facilitate the preparation of finan¬ 
cial or business statements. 

2. Draft journal entries for closing the books. 

The following items are to be taken into consideration: 


Inventories: 

Raw Materials. $16,250.00 

Finished Goods. 9,386.00 

Tools . 2,000.00 

Office Furniture. 1,000.00 

Furniture and Fixtures. 1,500.00 

Stationery and Printing. 300.00 


Allow for depreciations: on machinery, 5%; on horses, 
wagons and harness, 10%. 

Reserve for bad debts, 3% on accounts receivable only. 

The item for rent, $19,500, is to be apportioned as fol¬ 
lows: 53% for factory, 22% for salesrooms, and 25 % for 
office. 

The item of superintendence, $3,500, is to be divided, 
y 5 to factory and % to general expense. 




























400 


FINANCIAL STATEMENTS 


Solution 


The arrangement of the trial balance need not, in this 
instance, be particularly respectful of the different theories 
which dictate the position to be occupied in the statement of 
income by the sundry elements of income, profits, expenses, 
and losses. These theories will be fully explained later. 
Let it be sufficient, at this point, to be orderly and logical. 
The purpose of the working sheet will stand out clearly at 
all events. 

Having classified the trial balance, the first care should 
be to journalize the adjustments to be made, and to post the 
journal entries in the working papers, precisely as we would 
in the ledger. 

Journal Entries 


Inventory Raw Materials—New Account. $16,250.00 

Inventory Finished Goods “ “ 9,386.00 

Tools “ “ 2,000.00 

Office Furniture “ “ 1,000.00 

Furniture and Fixtures “ “ 1,500.00 

Stationery and Printing “ “ 300.00 

To Inventory Raw Materials—Old Account $16,250.00 

“ Inventory Finished Goods “ “ 9,386.00 

Tools “ “ 2,000.00 

“ Office Furniture “ “ 1,000.00 

“ Furniture and Fixtures “ “ 1,500.00 

“ Stationery and Printing “ “ 300.00 

To apply closing inventories. 


Provision for Depreciation of Machinery and 

Plant, 5%. 617.50 

Provision for Depreciation of Delivery Equip¬ 
ment, 10%. 850.00 

To Reserve for Depreciation. 1,467.50 

To provide for depreciation of physical assets. 

Reserve for Bad Debts. 2,696.22 

To Surplus. 2,696.22 


To reduce reserve to 3% of balance of asset 
account, i.e., $101,026.00. 













TRIAL BALANCE—WORKING BALANCE SHEET 


401 


Factory Rent 53%. 10,335-00 

Rent of Salesroom 22%. 4,290.00 

Rent of Office 25%. 4,875.00 

100% 

To Rent. 19,500.00 

To distribute. 

Superintendence—Factory 3/5. 2,100.00 

Office Salaries 2/5. 1,400.00 

5/5 

To Superintendence. 3,500.00 

To distribute. 

Tools Consumed. 600.00 

Furniture and Fixtures Written Off. 450.00 

Office Furniture Written Off. 100.00 

To Tools . 600.00 

“ Furniture and Fixtures. 450.00 

“ Office Furniture. 100.00 

To apply loss due to reappraisal of above 
properties. 

Stationery and Printing Consumed. 780.00 

To Stationery and Printing... 780.00 

To take out of asset account the part of it 
which is nominal. 

Inventory of Raw Materials. 4,857-30 

To Profit and Loss. 4,857.30 

For increase of inventory. This will act in the 


Profit and Loss account as a reduction of 
the cost of goods purchased, and determine 


the cost of goods manufactured. 

Inventory of Finished Goods—Old Account. 5,701.43 

To Profit and Loss. 5 , 701-43 


For increase of inventory. This will act in the 
Profit and Loss account as a reduction of 
the cost of goods manufactured, and deter¬ 
mine the cost of goods sold. 


The adjusting entries having been made, the closing 
entries would consist in gathering all items constituting 
classes of economic facts, and closing them by classes in the 
Profit and Loss account, in order to make the latter repro¬ 
duce accurately the skeleton of the statement of income and 






















402 


FINANCIAL STATEMENTS 



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Superintendence . 3,500.00 . 3,500.00 


TRIAL BALANCE—WORKING BALANCE SHEET 


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FINANCIAL STATEMENTS 


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TRIAL BALANCE—WORKING BALANCE SHEET 405 

profit and loss; these entries will be omitted here as im¬ 
material so far as the illustration of the working sheet is 
concerned. 

The picture presented by the foregoing working balance 
sheet is an exact reproduction, just before closing, of a 
highly analytical and well-planned ledger. Sometimes the 
accountant carries his preliminary work still further, and 
distributes the income debits and credits as follows: 

1. Distribution of Income Debits 

a. Cost of Goods 

(1) Labor 

(2) Material 

(3) Overhead 

b. Shipping Expense 

c. Selling Expense 

d. Administrative Expense 

e. Deductions from Income 

f. Profit and Loss Debits 

g. Surplus Adjustment 

h. Deductions from Income from Sales 

2. Distribution of Income Credits 

a. Income from Sales 

b. Additions to Income 

c. Profit and Loss Credits 

d. Surplus Adjustment 


CHAPTER XXXV 


THE BALANCE SHEET 


Arrangement as to Assets and Liabilities 

The balance sheet exhibits the balances of the real ac¬ 
counts open on the books after the closing of the nominal 
accounts. Whether these balances shall be presented in ac¬ 
count form, i.e., assets on one side and liabilities on the 
other side of a sheet divided in the middle, or in statement 
form, i.e., assets following liabilities, or vice versa, is imma¬ 
terial to accounting. 

Whether the assets are shown on the credit side or on 
the debit side, depends upon the point of view. If we con¬ 
sider the balance sheet as a classified statement of financial 
facts contained in the general ledger, we shall naturally 
present the facts as they stand on the ledger, that is to say, 
debits on the left and credits on the right if the account form 
is adopted, or assets first and liabilities second if the state¬ 
ment form is adopted. 

It has been said by English accountants that the balance 
sheet is an account rendered by the business to the proprietor. 
If we accept this view, we must credit the proprietor with his 
assets and debit him with his liabilities. If, on the other 
hand, we take the balance sheet to be purely and simply a 
concrete presentation of financial facts, we must understand 
the business venture to say: 

1. I have 

2. I owe 


406 


THE BALANCE SHEET 


407 


Arrangement as to Order of Items 

The desire of accountants to make the balance sheet 
valuable as a logical presentation of facts, has led them to 
build it up on lines which are as varied as the range of their 
minds. Some practitioners oppose : 

1. Capital assets and working and trading assets to 

capital liabilities 

2. Current assets to current liabilities 

3. Deferred debit items to deferred credit items 

Group 1 represents the actual investment of capital con¬ 
tributed or borrowed, in fixed assets and in assets remaining 
unconsumed in pursuance of the purpose of the business. 

Group 2 represents the excess of liquid assets over 
the amount of short-term debts, or vice versa. 

Group 3 represents positive and negative elements the 
application of which to income is postponed until a subse¬ 
quent period. 

The result represents the equity in undivided profits re¬ 
invested, and either appropriated for reserves, or free for 
distribution; and, by adding to this the capital account of the 
private trader, or the capital stock of the corporation, the 
true equity of the interested parties is found. This is illus¬ 
trated by the balance sheet which follows: 

General Balance Sheet of the X. Y. Z. Company 

at December 31, 1913 

Assets 


Capital Assets: 

Land . 

Building . 

Machinery and Tools. 

Transportation Equipment 


$5,000.00 

10,000.00 

11,300.00 

2,500.00 $28,800.00 







408 


FINANCIAL STATEMENTS 


General Balance Sheet —Continued 
Working and Trading Assets: 


Inventory of Merchandise. 

Stable Supplies. 

Stationery and Printing. 


17,420.00 

Current Assets: 

Cash. 

Notes Receivable. 

Accounts Receivable. 


22,215.00 

Deferred Debit Items: 

Rent—unexpired portion. 

Insurance—unexpired portion. 


140.00 

Total. 


$68,575.00 


Liabilities 

Capital Liabilities: 

Capital Stock. $40,000.00 

Mortgage Payable. 5,800.00 $45,800.00 


Current Liabilities: 

Accounts Payable. 12,350.00 

Surplus: 

Free . $8425.00 

Appropriated: 

Reserve for Depreciation. 1,000.00 

Reserve for Bad Debts. 1,000.00 10,425.00 

Total. $68,575.00 


Equity of stockholders: 

Assets. $68,575.00 

Liabilities exclusive of capital stock. . 18,150.00 


Excess of assets over liabilities to outsiders.$50,425.00 



































THE BALANCE SHEET 
Equity represented by: 


409 


Capital stock.. 
Surplus: 

Free. 

Appropriated 


$40,000.00 


$8,425.00 

2,000.00 10,425.00 


$50,425.00 


Variations in Arrangement of Balance Sheet 

Other accountants prefer to exhibit first of all the liquid 
assets opposed to liquid liabilities. They claim that nothing 
matters more to the reader of the statement than the ex¬ 
tent of the free capital available for current needs. Still 
others like to show: 

1. All the assets, without particular regard to their 

classification 

2. All the liabilities to outsiders 

3. The extent of the proprietorship represented by: 

a. Capital investments as shown by capital ac¬ 

counts or capital stock 

b. Surplus 

c. Reserves 

d. Deferred credit items 

Lastly, some will show all reserves as deductions from 
the assets for which they provide, while others will show 
them either as liabilities or as proprietorship. 

It is certain that in the expression of the facts, the in¬ 
dividual accountant is guided either by his purpose or by the 
extent of his conception of the science of accounting. To 
criticize is often tantamount to a lack of appreciation of the 
guiding purpose, or to lack of charity for the supposed short¬ 
comings of men whom we measure according to our own 
exalted standards. It remains true, however, that the bal- 









4io 


FINANCIAL STATEMENTS 


ance sheet of going concerns is built up around principles 
of economics, of finance, and of business common sense. 

The unsophisticated student of accounting can readily 
be made to understand that a balance sheet at any given date 
is only one of the components of a series of statements 
which, in the aggregate, exhibit clearly the fortunes of the 
business venture. The simplest way to demonstrate this is 
to explain the mechanism of the double-form balance sheet. 

Double-Form Balance Sheet 

The theory underlying this form is to the effect that 
every enterprise is divided into two distinct parts: 

1. The financing branch 

2. The operating branch 

At the incipiency of the enterprise, the financing branch 
obtains the required capital, acquires the needed assets, and 
places at the disposal of the operating branch certain “work¬ 
ing and trading” assets, and certain “current” (or liquid) 
assets free from, or subject to, certain “current” liabilities. 
The net value of the assets thus transferred is charged to the 
operating branch, and remains untouched until the period 
for an accounting has matured. Giving expression to the 
above in double balance sheet form, we obtain: 


THE BALANCE SHEET 


411. 

General Balance Sheet of. 

at. 


Financing 


Assets 


Liabilities 

Plant and Machinery. 

$300,000.00 

Capital Stock. $400,000.00 

Shop and Hand Tools. 

20,000.00 

Real Estate Mortgage. 60,700.00 

Shafting, Belting, and 



Pulleys. 

5,000.00 


Travelling and Sta- 



tionery Cranes. 

6,500.00 


R. R. Siding and 



Equipment. 

3,400.00 


Flasks and Patterns... 

1,800.00 


Patents and Good-Will 

45,000.00 


Organization Expense. 

4,000.00 


Operating Branch. 

75,000.00 



$460,700.00 

$460,700.00 


OrERATING 


Assets 

Manufacturing Materials $62,000.00 


Sundry Supplies. 2,000.00 

Cash on Deposit. 30,000.00 

Cash on Hand. 1,000.00 


$95,000.00 


Liabilities 


Accounts Payable. $20,000.00 

Financing Branch. 75,000.00 


$95,000.00 


Periodical Fluctuations in Double-Form Balance Sheet 

As operations progress, the operating branch transforms 
working assets into current assets, and current assets into 
working assets; current liabilities are also incurred in ex¬ 
change for assets, or for valuable services. As a result, the 
operating branch obtains profits measured by the excess of 
the increases of assets plus decreases of liabilities, over de¬ 
creases of assets plus increases of liabilities. 
































412 


FINANCIAL STATEMENTS 


The profits made by the operating branch are credited to 
surplus by the financing, and charged to the operating branch 
when the latter retains them for current needs. As to the 
operating branch, it correspondingly debits Profit and Loss, 
in order to close that account, and credits “Financing” from 
whom it has borrowed profits. 

If the profits are distributed to the stockholders by the 
financing branch, the account with the operating branch is 
credited with the amount of liquid assets withdrawn from 
it to liquidate the debt. Operating, in turn, debits the ac¬ 
count with “Financing,” and credits the asset with which 
it has parted. 

Thus, from period to period, the fluctuations of the ac¬ 
count “Operating Branch” found in the “Financing” part 
of the double-form balance sheet, show the gradual increase 
of the wealth of the concern. 

If no distribution of the profits has taken place, and if 
the profits have remained reinvested in the operations, then 
the correlation is absolute. If the profits have not been 
distributed, but have been withdrawn in part from operations 
for the purpose of acquiring additional capital assets, the 
aggregate amount of the favorable fluctuations is to be 
found: 

1. In the increase of the account “Operating” 

2. In the increase of the capital assets 

both being measured in total by the amount of the surplus 
appearing in the financing section. If the profits have been 
partially distributed, the aggregate of the profits made since 
the incipiency of business is obtained by the addition of 
(i) the charges to net profits for dividends, shown by the 
statement of income; (2) the increase of the “operating” 
account; ( 3 ) the increases of “capital assets.” 

Simple, logical, and lucid as it may be, the double-form 
balance sheet is seldojn used in America. Its lack of popu- 


THE BALANCE SHEET 


413 


larity is probably due to a conviction that the purpose of a 
balance sheet is to exhibit financial status at any given date, 
and that the periodical fluctuations of that status are better 
shown by the statement of income. But, whether or not 
the double form is used, it remains true that its logical spirit 
should influence the mechanism of all balance sheets. 

Opposition of Balance Sheet Items 

Whatever may be the nature of the fixed assets acquired 
out of capital contributed and borrowed, they should be 
opposed to the long-term liabilities to insiders and to out¬ 
siders, incurred for their acquisition; and the same is true of 
current assets and of current liabilities. The status of the 
working and trading assets is not quite so clear. Certain ac¬ 
countants say that they are “current” precisely like cash or 
accounts receivable, since they can be readily disposed of, 
either as they stand if they are trading assets, or in their raw 
state if they are working assets. 

It must be admitted that if the financial ease or distress 
of a concern are to be measured by the correlation existing 
between current assets and current liabilities, it would often¬ 
times be unfair to separate working and trading assets from 
the current liabilities incurred to obtain them. It is probably 
for this reason that the Interstate Commerce Commission 
has done away with the terms “Working and Trading” 
and “Current,” and has blended the two under the head¬ 
ing “Working Assets,” which it opposes to “Working 
Liabilities.” 

Form of General Balance Sheet 

To illustrate the foregoing, and prepare the ground for 
further discussion, the following comparative general bal¬ 
ance sheet of the Black Diamond Manufacturing Company 
at December 31, 1912, and at December 31, 1913, is 
presented. 


4H 


FINANCIAL STATEMENTS 


The Black Diamond Manufacturing Company 

Comparative General Balance Sheet at December 
31, 1912, and at December 31, 1913 

December December Increases 
31, 1912 31, 1913 Decreases* 


Assets and Deferred Debit Items: 
Capital Assets: 

Land . 

Factory and Office Buildings. 

Building Equipment. 

Power Plant. 

Machinery and Tools. 

Experimental and Improvement 

Plant . 

Maintenance Plant. 

Printing Plant. 

Transportation Plant. 

Furniture and Fixtures. 

Trade-Marks and Patents. 

Total Capital Assets. 

Working and Trading Assets: 
Working: 

Goods in Process—Inventory.... 
Manufacturing Materials and Sup¬ 
plies—Inventory . 

Materials for Repairs and Main¬ 
tenance—Inventory .'. 

Scrap Material—Inventory. 

Shipping Material—Inventory. ... 
Coal, Oil and Waste—Inventory.. 

Advertising Matter. 

Stationery and Printing. 

Trading: 

Finished Goods—Inventory. 

Total Working and Trading. 

Total Capital and Working and 
Trading Assets. 


$57,157.00 

$ 57 , 157-00 


70,990.44 

70,990.44 


13,105.41 

13 , 439.27 

$ 333-86 

15,904.02 

16,404.43 

500.41 

36,050.74 

39 , 471-77 

3,421.03 

3,472.03 

3,481.21 

9.18 

6,218.84 

6,312.06 

93-22 

669.25 

669.25 


5,769.68 

7 , 329 .oi 

1 , 559-33 

4,369.96 

4 . 654.94 

284.98 

2,382.78 

2,692.02 

309.24 

$216,090.15 

$222,601.40 

$6,511.25 


$12,388.04 

$10,299.68 

$2,088.36 

26,555-65 

36,653.27 

10,097.62 

3 , 953 - 6 o 

6,350.65 

2 , 397-05 

218.86 

257-22 

38.36 

114.78 

220.19 

105.41 

97.00 

97-30 

•30 

11,251.97 

10 , 473-33 

778.64 

50.56 

55-70 

5-14 

$54,630.46 

$64,407.34 

$9,776.88 

56,631.05 

53 , 65 i.u 

2 , 979-94 

$111,261.51 

$118,058.45 

$6,796.94 

$ 327 , 35 l 66 

$340,659.85 

$13,308.19 


* Decreases are shown in italics. 












































THE BALANCE SHEET 
Comparative General Balance Sheet —Continued 


415 


Current Assets: 

Cash in Banks and in Office. 

Special Deposits. 

Notes Receivable. 

Customers’ Accounts Receivable.. 
Claims against Transportation 

Cos. 

Advances to Employees. 

Total Current Assets. 

Deferred Debit Items: 

Fire Insurance Premiums, un¬ 
expired portion. 

Freight and Cartage Outward, ap¬ 
plicable to goods finished, ware¬ 
housed, and unsold. 

Total Deferred Debit Items. 

Total Current Assets and Deferred 
Debit Items. 

Total Assets and Deferred Debit 
Items . 


Liabilities and Surplus : 

Capital Liabilities: 

Capital Stock Authorized, Issued 

and Outstanding. 

Real Estate Bond and Mortgage.. 

Total Capital Liabilities. 

Current Liabilities: 

Notes and Loans Payable. 

Accounts Payable: 

a. To Creditors. 

b. “ Employees — Wages Ac¬ 

crued . 


December 
31, 1912 

$1,865.61 

11,093.23 

39 , 588.75 

529-08 

951-57 

December 

3 i, 1913 

$18,773.15 

14,690.40 

1,000.00 

53 , 376.04 

732.32 

589.08 

Increases 

Decreases* 

$16,907.54 

3 , 597.17 

1,000.00 

13,787.29 

203.24 

362.49 

$54,028.24 

$89,160.99 

$ 35 , 132.75 

$ 1 , 583.33 

$1,411-85 

$171.48 


3,670.46 

3,670.46 

$1,583-33 

$5,082.31 

$ 3 , 498.98 

$ 55 , 6 ii .57 

$94,243.30 

$38,631.73 

$382,963.23 

$ 434 , 903.15 

$51,939.92 


$50,000.00 

109,100.00 

$50,000.00 

98,300.00 

$10,800.00 

$159,100.00 

$148,300.00 

$10,800.00 

$31,700.00 

$18,749.96 

$12,950.04 

8 , 953-12 

1,581.79 

7 , 371-33 

774.82 

10,717.24 

9,942.42 


* Decreases are shown in italics. 

















































416 


FINANCIAL STATEMENTS 


Comparative General Balance Sheet —Continued 



December 

December 

Increases 


31, 1912 

31 , 1913 

Decreases* 

c. To Salesmen—Salaries, Com- 

missions and Expenses 

1,182.20 

3,588.19 

2 , 405.99 

d. “ Employees—Profit Shar- 

ing Scheme. 

9,689.28 

734-79 

8,95449 

e. “ Employees—Deposits for 

Use of Tools. 

10.75 

63.58 

52.83 

f. “ State—For Taxes. 


1,116.12 

1,116.12 

Total Current Liabilities. 

$52,310.17 

$36,551.67 

$ 15 , 758.50 

Total Liabilities. 

$211,410.17 

$184,851.67 

$26,558.50 

Surplus: 
a. Appropriated: 

For Reserves for Claims 

against Transportation 
Companies . 

$184.75 

$56973 

$384.98 

For Reserves for Deprecia- 

tion of Physical Assets.... 


9 , 48 i .39 

9 , 481.39 

For Possible Losses of Ac- 

counts Receivable. 


2 , 715.34 

2 , 715-34 

Total Appropriated. 

$184.75 

$12,766.46 

$12,581.71 

b. Available for Dividends. 

171,368.31 

237,285.02 

65,916.71 

Total Surplus. 

$i 7 L 553 .o 6 

$250,051.48 

$78,498.42 

Total Liabilities and Surplus. 

$382,963.23 

$ 434 , 903.15 

$ 5 L 939.92 


* Decreases are shown in italics. 

Attention is called to the fact that the apparent differ¬ 
ences in handling the facts of the two periods covered by 
these balance sheets, are due to a change of accounting 
policy.! 

Reading a Balance Sheet 

The reading of a balance sheet depends, of course, upon 
the way the facts are presented. In the foregoing example, 


t See reserves. Chapter XXIV, and deferred debit items, Chapter XXVL 










































THE BALANCE SHEET 


417 


it is plain that, as between the beginning of operations and 
the closing date of the last period, $340,659.85 of capital 
and working and trading assets have been obtained out of 
$148,300.00 of capital liabilities, and that $94,243.30 of 
current assets and deferred debit items have been obtained 
out of $36,551.67 of current liabilities. Thus, the excess 
of capital assets, $192,359.85 (including working and trad¬ 
ing assets), over the capital liabilities, and the current assets, 
$57,691.63 (including deferred debit items), must in the 
aggregate, represent reinvested profits as measured by sur¬ 
plus in its two components, (1) appropriations for reserves, 
(2) available for distribution. Correspondingly, it is evi¬ 
dent that as between the two periods ended December 31, 
1912, and December 31, 1913, the aggregate of the increase 
of capital assets, $13,308.19 (including working and trad¬ 
ing assets), and of the decrease of capital liabilities, $10,- 
800.00, or altogether $24,108.19; and the aggregate of the 
increase of other assets, $38,631.73, and of the decrease of 
current liabilities, $15,758.50, or altogether $54,390.23, 
represent a sum of $78,498.42 which must give the increase 
of surplus of the last period over the preceding one. 


( 


CHAPTER XXXVI 

SPECIAL FORMS OF BALANCE SHEETS 

Bank Balance Sheet 

The classification of the balance sheet, as suggested in 
the preceding chapter, does not apply to financial corpora¬ 
tions, insurance companies, and public utilities corporations, 
regulated by the Interstate Commerce Commission or by 
public service commissions. The classification of the balance 
sheet of a bank is indicated by the purpose of the institu¬ 
tion itself, considered in connection with the purpose of the 
depositor. The purpose of the bank is to invest the money 
intrusted to it by depositors, or to hold it in reserve, subject 
to call, in exchange for a compensation which represents the 
difference between the earnings of the depositor’s funds, and 
the amount of such earnings as the depositor is willing to 
accept under the form of interest, together with the expenses 
of conducting the enterprise. 

The purpose of the depositor is to place his money in a 
safe place, to receive interest on his deposits, and to simplify 
means of exchange by issuing orders upon the bank to remit 
to others or to pay to him such funds as he wishes to with¬ 
draw. It follows that the all-essential thing in the balance 
sheet of a bank is to arrange the assets so as to show: 

1. The investments of different nature, required by law 

or otherwise, which, while liquid in principle, are 
not as yet converted into cash. 

2 . The specie, legal tender notes, certificates of deposit, 

held ready for payment over the counter. 

418 


SPECIAL FORMS OF BALANCE SHEETS 


419 


3. The other assets of the bank acquired by the direc¬ 
torate out of capital contributions or out of profits 
accumulated for reinvestment. 

As to the liabilities, if there ever is a reason for bringing 
in the liabilities to outsiders before the liabilities to stock¬ 
holders, that reason is to be found in the balance sheet of a 
bank. That banks do not always reason as accountants do, 
is evidenced by the following balance sheet which gives the 
form used by a national bank of New York City. This 
shows the bank buildings and fixtures before the cash re¬ 
sources of the bank, and the capital stock before the liabilities 
to depositors. 


Balance Sheet of National Bank 

Resources 


Loans and Discounts. $3,340,988.75 

Bills Discounted: 

Single Name. $836,434.00 

Double Name. 490,191.13 

Collateral Loans. 469,810.00 $ 1 , 796 , 435-13 


Demand Loans: 

Secured by Collateral.$692,604.47 

Not Secured. 63,306.90 755 , 911-37 


Time Loans. 663,500.00 

($i77,5oo of these are hypothecated.) 

Foreign Bills. 89,936.65 

Past-Due Paper. 35, 2 05-6o 


U. S. Bonds and Premium. 

U. S. Bonds for Circulation . $250,000.00 

U. S. Bonds for Deposits. 50,000.00 

Premium on September 15, 1913. 1,437-50 


Investments . 

Florida Transportation Co. Bonds. $17,600.00 

Second Mortgage on Real Estate. 6,500.00 

Milltown Mining and Brick Bonds. 20,000.00 

17th Avenue Property. i 44 , 59 J -99 

1 st Avenue Property. 4 2 , 2 97-33 

Long Island Sound Tunnel Bonds. 50,000.00 


301 , 437-50 


280,989.32 



























420 


FINANCIAL STATEMENTS 


Balance Sheet— Continued 


Bank Buildings and Fixtures. 

Land and Building. $106,011.45 

Furniture. 12,788.50 


Due from Banks. 

Twelfth National Bank. $159,751.20 

Twentieth Century Bank. 31,634.88 

East Side National Bank. 20,095.12 

Bank of Newton. 7,340.22 

West End Bank. 3,138.88 

Sundry Checks out for collection. 11,691.20 


Cash and Reserve. 

Cash (See report for particulars). $516,950.35 

Cash deposited with U. S. Treasurer for 

Redemption Fund. 25,000.00 

First National Bank.*. 203,890.11 

Tenth Avenue National Bank. 122,535.58 

German National Bank. 103,240.40 


Liabilities 

Capital Stock... 

3,500 shares of $100 each, fully paid. 

Surplus . 

Balance of Surplus, November 15, 1912.. $500,000.00 

Added from Profit during year to No¬ 
vember 15, 1913. 15,000.00 

Undivided Profits. 

Balance of Account, November 15, 1912.. $49,894.07 

Profit for year ended November 15, 1913 40,238.78 


Less: $90,132.85 

Dividends Paid. $23,800.00 

Transferred to Surplus. 15,000.00 38,800.00 


Balance of Account. $51,332.85 

Circulation. 

•Authorized Circulation. $250,000.00 

Deduct Circulation held by Comptroller.. 1,700.00 


118,79995 

233,651.50 


971,616.44 


$5,247,483.46 

$350,000.00 

515,000.00 

5 L 332.85 


248,300.00 







































SPECIAL FORMS OF BALANCE SHEETS 


421 


Balance Sheet— Continued 


Due Other Banks. 

Twentieth Century Bank. $163,824.49 

Twelfth National Bank. 23,615.80 

Bank of Oldtown,. 10,535.22 


197,975.51 


Bills Payable (Secured). 

(Due to other national banks—secured by 
time loans hypothecated.) 

Dividend Checks Not Presented. 


Deposits . 

Individual. $3,507,085.07 

Certified Checks. 9,071.48 

Cashiers’ Checks. 36,129.48 

Certificates of Deposit. 52,409.07 

Transient Collections. 615.00 

United States Deposit. 100,000.00 

Teller’s Due Bills. 865.00 


177,500.00 


1,200.00 

3,706.175.10 


$5,247,483.46 


The Balance Sheet of Life Insurance Companies 

The form of the balance sheet required of life insurance 
companies by the Insurance Department of the State of New 
York is given here in full detail. It follows the proof of 
ledger assets, reference to which has been made in the fore¬ 
going. It is especially interesting because it divides assets 
into: 


( a. Ledger Assets 
| b. Non-Ledger Assets 

2. Assets not admitted, which must be deducted from 
the sum of all the assets in order that the truly 
available funds may be ascertained. 

The term “Non-Ledger Assets” does not refer, as one 
accountant said in scorn, to assets owned but, for some un¬ 
known and discreditable reason, not placed on the books; 
but to assets accrued which may not be on the books at any 
time other than the end of the calendar year, if such is the 
policy of the concern 





















Form of Balance Sheet of Life Insurance Company 
as Prescribed by the Superintendent of 
Insurance, State of New York 


1. 

2 . 


3. 


4 . 


5. 


6 . 

7. 

8 . 

9. 


10 . 


11 . 


LEDGER ASSETS 


Book value of real estate, per Schedule A. 

Mortgage loans on real estate, per Schedule B, first liens, $....; other 

than first liens, . 

Loans secured by pledge of bonds, stocks or other collateral, per 

Schedule .. 

Loans made to policyholders on this company's policies assigned as col¬ 
lateral . 

Premium notes on policies in force, of which $.... is for first year’s 

premiums . 

Book value of bonds, $....; and stocks, $....; per Schedule D. 

Cash in company's office. $. 

Deposits in trust companies and banks, not on interest, per 

Schedule E. 

Deposits in trust companies and banks, on interest, per 

Schedule E. 




Bills receivable, $....; agents’ balances (debit, $....; credit, 
net, . 


12 . 


Total Ledger Assets, as per “balance” on page 3 


NON-LEDGER ASSETS 

13. Interest due, $....; and accrued, $_ on mortgages, per Schedule B.. 

14. Interest due, $.... and accrued, $.... on bonds, per Schedule D, Part 1 

15. Interest due, $.... and accrued, $.... on collateral loans, per Schedule 

C, Part 1.. 

16. Interest due, $...., and accrued. $.... on premium notes, policy loan3 

or liens . 

[ 17. Interest due, $.... and accrued, $- on other assets (give items 

and amounts): 

18. 

19. 

20. Rents due, $.... and accrued, $.... on company's property or lease.... 



$.. 



21 . 

22 . 

23. 

24. 


25. 

26. 


27. 

28. 


29. 


30. 

31. 

32. 

33. 

34. 


35. 


36. 

37. 

38. 

39. 

40. 

41. 

42. 

43. 

44. 

45. 

46. 


Total interest and rents due and accrued 

Market value of real estate over book value, per Schedule A. 

Market value (not Including interest in Item 14), of bonds and stocks over book 

value, per Schedule D. 

Due from other companies for losses or claims on policies of this company, re¬ 
insured . 


Gross premiums due and unreported on policies in force Decem¬ 
ber 31, 1912 (less reinsurance premiums). 

Gross deferred premiums on policies in force December 31, 
1912 (less reinsurance premiums). 

Totals 

Deduct loading. 

Net amount of uncollected and deferred premiums. 


(1) New 
Business 

$. 

(2) 

Renewals 

$. 





$. 

$. 





$. 

$. 




All other assets (give items and amounts): 


Gross Assets 

DEDUCT ASSETS NOT ADMITTED 



Company's stock owned $_; loans on $_; . 

Supplies, stationery, printed matter, $_; furniture, fixtures and safes. 


Commuted commissions, $....; agents’ debit balances, gross, $....; .... 

Cash advanced to or in the hands of officers or agents. 

Loans on personal security, endorsed or not, $....; bills receivable, $.... 
Premium notes and loans on policies and net premiums in Item 29 in 

excess of net value of their policies. 

Overdue and accrued interest on bonds in default. 

Book value of Ledger Assets over market value, viz.: 


Admitted Assets 



























































































LIABILITIES, SURPLUS AND OTHER FUNDS 

x^et present value of all the outstanding policies in force on the 31st 

day of December, 1912, as computed by the. 

on the following tables of mortality and rates of interest, viz.: 

1. Actuaries' table at-per cent, on*. 







« 






Same for reversionary additions. 



$.. 



2. 

American Experience table at_ per cent, on*. 













Same for reversionary additions. 





3. 

American Experience table at....per cent, on*. 












Same for reversionary additions. 






4. 

Other tables and rates, viz. :* 

$.. 






































Same for reversionary additions. 






5. 

Net present value of annuities (including those in reduction of 
premiums). Give tables and rates of interest, viz.: 

$.. 







































Total . 






1. 

Deduct net value of risks of this company reinsured in other solvent 
companies . 



7. 

Reserve to provide for health and accident benefits contained in life policies 


... 


8. 

Net Reserve (Paid-for basis). 






9. 

Present value of amounts not yet due on supplementary contracts 
involving life contingencies, computed by the. 

not 



10. 

Liability on policies cancelled and not included in “net reserve” 
which a surrender value mav be demanded.. 

upon 




11. 

Claims for death losses due and unoaid. 



$ 



12. 

13. 

14. 

Claims for death losses in process of adjustment, or adjusted and not due 
Claims for death losses incurred for which no proofs have been received 
Claims for matured endowments due and unpaid. 


... 


15. 

16. 

Claims for death losses and other policy claims resisted by the company 
Due and unpaid on annuity claims involving life contingencies. 


• • • 


17. 

Total Policy Claims. 











. « • 

18. 

19. 

Due and unpaid on supplementary contracts not involving life contingencies. 

Dividends left with the company to accumulate at interest, and accrued interest 

thprprm . ... _ 

... 

20. 

21. 

Prpminms naid in advance. Including surrender values so annlied. 





Unearned interest and rent paid in advance........" 






22. 

Commissions due to agents on premium notes wheTl paid. 






23. 

Commissions to agents, due or accrued. 






24. 

“Cost of collection” on uncollected and deferred premiums, in excess 
thereon. 

of the loading 


25. 

26. 
27. 

Salaries, rents, office expenses, bills and accounts due or accrued.. 





Hfpdipal pTaminprs’ fpps S and leeal fpps $ . due or ac.crupd . 





Estimated amount hereafter payable for federal, state, and other taxes based 

fhp hnsinpss of thp vpa. of rhis statement. 

upon 


28. 

29. 

Advances by officers or others on account of expenses of organization or 
Rorrowpd mrvnpv $ and interest, t.hereon . 

otherwise 


30. 

TTnnaid dividend** tn stnokh older** . . 






31. 

Dividends or other profits due policyholders, including those contingent on payment 
of outstanding and deferred prpminms . . . 


32. 

Dividends declared on or apportioned to annual dividend policies payable to policy¬ 
holders during 1913, whether contingent upon the payment of renewal pre¬ 
miums or otherwise... . 


33. 

Dividends declared on or apportioned to deferred dividend 
nolicvholders during 13. 

policies payable to 


34. 

Amounts set apart, apportioned, provisionally ascertained, calculated, declared or 
held awaiting apportionment upon deferred dividend policies, not included in Item 


35. 

36. 

Reserve, special or surplus funds not included above (give items 
rately, and state for what purpose each of said funds is 

and amounts sepa- 
held): 


37. 







38. 







39. 

40. 

All other liabilities (give items and amounts): 






41. 







42. 







43. 







44. 

Capital stock. 





45. 

Unassigned funds (surplus). 






46. 

Total. 





$.. 








•'state definitely the dates of Issue and class of policies covered hy each basis of 
valuation. 





































































































FINANCIAL STATEMENTS 


424 

Balance Sheet of Steam Roads Engaged in Interstate Com¬ 
merce 

The form presented here is nothing more than the ex¬ 
pression of the requirements of the Interstate Commerce 
Commission, as formulated in their pamphlet (first revised 
issue effective June 15th, 1910) entitled “General Balance 
Sheet Statements as prescribed by the Interstate Commerce 
Commission for Steam Roads, in accordance with Section 
20 of the Act to regulate Commerce.” 

Balance Sheet Statement 

Assets 

Property Investment: 

I. Road and Equipment: 

Investment to June 30, 1907: 

Road. $. 

Equipment. 

Investment since June 30, 1907: 

Road . 

Equipment. 

General Expenditures. 


Total Road and Equipment. $ 

Bic Reserve for Accrued Depreciation (Cr.).. . 

Total Road and Equipment.$ 


Bia 

Bib 


II. Securities: 

B2 Securities of Proprietary, Affiliated, and 

Controlled Companies—Pledged. $ 

B3 Securities Issued or Assumed—Pledged.. . 

B4 Securities of Proprietary, Affiliated, and 

Controlled Companies—Unpledged. 


Total Securities. $ 


III. Other Investments: 

B5 Advances to Proprietary, Affiliated, and 

Controlled Companies for Construc¬ 
tion, Equipment, and Betterments.$ 

























SPECIAL FORMS OF BALANCE SHEETS 


425 


Balance Sheet Statement — Continued 
B6 Miscellaneous Investments: 


Physical Property... 

Securities—Pledged. 

Securities—Unpledged . 

Total Other Investments.$. 

Total Property Investment.... $ 

Working Assets: 

B7 Cash.$. 


B8 Securities Issued or Assumed—Held in 

Treasury: 

Stocks . 

Funded Debt. 

Miscellaneous. 

B9 Marketable Securities: 

Stocks . 

Funded Debt. 

Miscellaneous. 

Bio Loans and Bills Receivable. 

Bn Traffic and Car Service Balances Due 

from Other Companies. 

B12 Net Balance Due from Agents and Con¬ 
ductors .. 

B13 Miscellaneous Accounts Receivable. 

B14 Materials and Supplies (Depreciation de¬ 
ducted) . 

B15 Other Working Assets. 

Total Working Assets. 

Accrued Income—Not Due: 

B16 Unmatured Interest, Dividends, and 

Rents Receivable. 

Deferred Debit Items: 

Bi 7 Advances: 

Temporary Advances to Proprietary, 
Affiliated, and Controlled Companies $ 

Working Funds. 

Other Advances. 

B18 Rent and Insurance Paid in Advance. 

Btp Taxes Paid in Advance. 


































FINANCIAL STATEMENTS 


426 

Balance Sheet Statement— Continued 

B20 Unextinguished Discount on Securities: 

On Capital Stock. 

On Funded Debt. 

B21 Property Abandoned, chargeable to 

Operating Expenses. 

B22 Special Deposits. 

B23 Cash and Securities in Sinking and Re¬ 
demption Funds. 

B24 Cash and Securities in Insurance and 

Other Reserve Funds. 

B25 Cash and Securities in Provident Funds. 

B26 Other Deferred Debit Items.. 

Total Deferred Debit Items.. 

Profit and Loss: 

B 27 Balance. 



Liabilities 


Stock: 

B28 Capital Stock: 

Held in Treasury: 

Common Stock.$ 

Preferred Stock. 

Debenture Stock. 


Total 


$ 


Issued and Outstanding: 

Common Stock. $ 

Preferred Stock. 

Debenture Stock. 

Receipts Outstanding for Instalments 


Paid. 

Total. $ 

B29 Stock Liability for Conversion of Securi¬ 
ties of Constituent Companies.$ 

B30 Premiums Realized on Capital Stock... . 



Total Stock 









































SPECIAL FORMS OF BALANCE SHEETS 

Balance Sheet Statement— Continued 

Bonded Mortgage and Secured Debt: 

B31 Funded Debt: 

Held in Treasury: 

(a) Mortgage Bonds.$. 

(b) Collateral Trust Bonds. 

(c) Plain Bonds, Debentures, and 

Notes . 

(d) Income Bonds. 

(e) Equipment Trust Obligations. 

(f) Miscellaneous Funded Obliga¬ 

tions . 


Total. $ 

Issued and Outstanding: 

(a) Mortgage Bonds.$ 


(b) Collateral Trust Bonds. 

(c) Plain Bonds, Debentures, and 

Notes ... 

(d) Income Bonds. 

(e) Equipment Trust Obligations... 

(f) Miscellaneous Funded Obliga¬ 

tions . 

(g) Receipts Outstanding for Funded 


Debt . 

Total.$ 

B32 Receivers’ Certificates.$ 


B33 Obligations for Advances Received for 

Construction, Equipment, and Better¬ 
ments . 


Total Bonded Mortgage and Secured Debt.. . 

r 

Working Liabilities: 

B34 Loans and Bills Payable. $. 

B35 Traffic and Car Service Balances Due to 

Other Companies. 

B36 Audited Vouchers and Wages Unpaid. 

B37 Miscellaneous Accounts Payable. 

B38 Matured Interest, Dividends, and Rents 

Unpaid . 


427 


••••••• 




































428 


FINANCIAL STATEMENTS 


B39 

B40 

B41 


B42 

B43 


B44 

B45 

B46 

B47 


B48 

B49 


B50 


Balance Sheet Statement— Continued 

Matured Bonded Mortgage and Secured 

Debt Unpaid. 

Working Advances Due to Other Com¬ 
panies . 

Other Working Liabilities. 

Total Working Liabilities. 

Accrued Liabilities—Not Due: 

Unmatured Interest, Dividends, and 

Rents Payable. $.. 

Taxes Accrued. 

Total Accrued Liabilities. 


Deferred Credit Items: 

Unextinguished Premiums on Outstand¬ 
ing Funded Debt.$ 

Operating Reserves. 

Liability on Account of Provident Funds . 
Other Deferred Credit Items. 

Total Deferred Credit Items. 

•Appropriated Surplus: 

Additions to Property since June 30, 1907, 

through Income. $ 

Reserves from Income or Surplus: 

Invested in Sinking and Redemption 

Funds . 

Invested in Other Reserve Funds.. 

Not Specifically Invested.. 

Total Appropriated Surplus.. 

Profit and Loss: 

Balance .. 

Total .. 



In departing from generally accepted accounting classifi¬ 
cations, the commission has fulfilled excellently its purpose, 
which was to control the presentation of facts by steam 
roads so that it would be possible to judge them all accord- 



































SPECIAL FORMS OF BALANCE SHEETS 


429 


ing to the same standard. The distinctions made between 
working assets and deferred debit items are at times a trifle 
academic, and it is not always easy to explain the reason 
why certain facts should be in one group, while other facts 
apparently similar in every respect are to be found in an¬ 
other group. Generally speaking, however, it may be said 
with propriety that the commissions’ requirements have re¬ 
flected a great amount of light upon the real value of 
financial facts which, in the past, were included in groups 
created to act as deflectors or as screens. 

The balance sheet of public utility corporations which 
are under the control of the various public service commis¬ 
sions created by the states of the Union, will not be found to 
differ greatly in spirit from the form given above for steam 
roads regulated by the Interstate Commerce Commission. 
They may, however, adopt a different terminology and per¬ 
haps, in a few instances, somewhat alter the requirements 
of the different groups. The powers of the said commissions 
in connection with uniform systems of accounting can only 
be obtained from the statutes creating them, or from amend¬ 
ments thereto brought about by the recommendations of the 
commissions themselves in their report to the state 
legislatures. 


{ 

CHAPTER XXXVII 


THE STATEMENT OF INCOME AND PROFIT 

AND LOSS 


Elements of Statement 

Speaking of a business enterprise as an abstract proposi¬ 
tion, the result of operations discloses: operating profits, 
operating losses, expense, profit and loss charges, profit and 
loss credits, income from sources other than operations; de¬ 
ductions from income and profits; adjustments of profits or 
losses of prior periods. 

“Operating Profit” is that part of the trading capital 
sent out which has returned in excess of the value of the 
outgo. 

“Operating Loss” is that part of the trading capital sent 
out which has not returned and will not return. 

“Expense” is that part of the invested capital which 
must be given up in exchange for such services as the busi¬ 
ness requires. 

“Profit and Loss Charges” are losses of capital incurred 
in a particular accounting period otherwise than through 
operations; they are due to the sale of non-trading assets 
below the cost thereof; to inefficiency, carelessness, 
malignity, or dishonesty of employees, or to natural causes 
over which the administration has no control. 

“Profit and Loss Credits” are gains of capital made in a 
particular accounting period otherwise than through opera¬ 
tions or through the regular and expected earnings of in¬ 
vested values. 


43 ° 





STATEMENT OF INCOME 


431 


“Income from Sources Other Than Operations’’ repre¬ 
sents the earnings of capital invested otherwise than to 
satisfy the requirements of t) - basic business purpose. 

“Deductions from Income and Profits” are the part of 
his income and profits which the business man must share 
with others for the use of their wealth in the conduct of his 
business, or must pay to others as a compensation for the 
safeguards with which they surround his business interests. 

“Surplus or Capital Adjustments” represent the changes 
which must be made in the net results of the operations of 
past periods in order that conditions unknown then, but now 
understood, may not erroneously affect the results of the 
prior period. 

When attempting to express the causes which have 
brought about operating profits or operating losses, it is 
necessary to state: 

1 . The amount of the values which have come in, in 

exchange for the values which have gone out 

2. The amount of the values which have gone out in ex¬ 

change for the values which have come in 

Non-trading concerns call the first group of facts re¬ 
ceipts, revenue, operating earnings, or any name which 
applies unequivocally to the particular operations of the 
enterprise. 

Trading concerns as well as manufacturing concerns en¬ 
gaged in trading, oppose sales to the cost of the goods sold. 
Accountants have taken the habit of calling sales “income 
from sales,” and deductions therefrom, “deductions from 
income from sales.” 

They have been led to this harmless distortion of the 
meaning of the word “income” by the praiseworthy desire 
of giving to the statement to be presented by them an 
anatomical aspect suggestive of logic, clarity, and analytical 
power. 


43 2 


FINANCIAL STATEMENTS 


The marshaling and the grouping of the various ele-. 
ments which constitute the sundry classes of financial facts 
indicated in the foregoing, is the purpose of the “Statement 
of Income and Profit and Loss.” 

Mechanism of Statement 

The mechanism of the “Statement of Income and Profit 
and Loss” is simplicity itself; it is as follows: 

1. The income from operations is given at its gross 
figure. From that gross figure are deducted all the items 
which have reduced it, either through cancellation of the 
original transactions, or through partial reductions thereof, 
or again through expenditures which were positively in¬ 
cluded in, and deductible from, the amount receivable from 
operations in accordance with the expressed or implied 
terms of the contract which made them possible. 

2. The cost of obtaining that income, i.e., the operating 
cost, is given next, in order that by its deduction, the gross 
profit represented by the excess of the returns over cost may 
be gauged. 

3. The cost of bringing about the conditions which 
made operations possible follows. When this is deducted 
the result, in mercantile as well as in manufacturing con¬ 
cerns, is known as the selling profit. 

4. If from the selling profit, the cost of administering 
the business is deducted, the resulting figure is the net 
income, or the profit from operations. 

5. To this profit is added the income obtained from 
other sources. 

6. From the sum of sections 4 and 5, there is deducted 
the voluntary or unavoidable sharing of income and profits 
with others who lend their financial or their protective 
assistance to the business. 

7. 8. To the remainder, the profit and loss credits are 


STATEMENT OF INCOME 


433 

added, and from the remainder the profit and loss charges 
are deducted. 

9. The result is the net profit from all sources, for the 
period. 

10. From this net profit there is to be deducted appropria¬ 
tions for contingencies of the future, that is to say, pro¬ 
visions for reserves. 

11. To this result there must be added the undivided pro¬ 
fits of the prior periods, adjusted by adding thereto, or de¬ 
ducting therefrom, the losses maturing during the present 
period and denying gains taken as such in a prior period 
(or vice versa if conditions are reversed). 

12. The result is, of necessity, the amount of undivided 
profits known as “surplus” in corporate balance sheets, and 
stated at the same figure by the statement showing the 
financial status. If the concern is a sole proprietorship, or 
a copartnership, the result of section 10 is added to the 
capital accounts of the proprietors adjusted as suggested in 
section 11. The result, then, is the actual equity of the 
proprietors in their assets, as expressed by the balance sheet. 

The following statement of income and profit and loss 
of the Black Diamond Manufacturing Company* will serve 
as an illustration: 

The Black Diamond Manufacturing Company 

Statement of Income and Profit and Loss 
for the Year Ended December 31, 1913 

Income from Sales: 

Gross Sales. $788,968.41 

Less Returns. 3 . 434-17 

Net Sales.*.$785,534.24 


* See balance sheet given in Chapter XXXV. 








434 


FINANCIAL STATEMENTS 


Statement of Income— Continued 


Deductions from Sales: 

Allowances to Customers: 

On Sale Price. $380.10 

* On Damaged Goods. 276.04 

Freight and Cartage Outward—on Sales. 40,300.00 

Stable and Automobile Expense—Proportion 
Applicable to Sales. 7,851.68 


Total Deductions from Sales. $48,807.82 


Income from Sales. 

Cost of Goods Sold: 

Manufacturing Cost of Goods Finished During the Period: 
Prime Cost: 

Materials and Supplies Consumed—Includ¬ 


ing Freight and Cartage thereon.$295,379.01 

Productive Labor. 55,316.83 

Total Prime Cost. $350,695.84 


Manufacturing Overhead: 

Superintendence. $ 7 , 370.49 

Unproductive Labor. 8,221.40 

Heat, Light, and Power. 3,677.82 

Factory Expense. 8,405.06 

Repairs and Maintenance, Machinery and 
Tools . 5,120.09 


Total Manufacturing Overhead. $32,794.86 


General Factory Overhead: 

Salaries and Wages—Shipping Department $7,982.36 

Shipping Material Consumed. 1,114.77 

Shipping Department Supplies. 9.21 

Miscellaneous Shipping Expense. 447-86 

Traveling Expense—Shipping Department.. 275.21 

Stationery and Printing Consumed by 
Factory . 7.53 


Total General Factory Overhead. $9,836.94 


Total Manufacturing Cost for the Period_$393,327.64 

Deduct: Increase of Inventory of Goods in 
Process as between January 1 and De¬ 
cember 31, 1913. 


$736,726.42 
































STATEMENT OF INCOME 


435 


Statement of Income —Continued 

Add: Decrease of Inventory of Goods in 
Process as between January i and Decem¬ 
ber 31, 1913. 2,088.36 


Manufacturing Cost of Goods Finished Dur¬ 
ing the Period. $395,416.00 

Inventory Adjustment: 

Deduct: Increase of Inventory of Finished 
Goods as between January 1 and December 
31, 1913, after deduction therefrom of the 
value of goods distributed free, and used 

by salesmen. 7,954-39 

Add: Decrease of Inventory of Finished 
Goods as between January 1 and Decem¬ 
ber 31, 1913, after deduction therefrom of 
the value of goods distributed free, and 
used by salesmen. 


Manufacturing Cost of Goods Sold. $387,461.61 

Additional Cost—Freight, Handling and Ware¬ 
housing of Raw Materials Consumed. 4,905.27 


Total Cost of Goods Sold 
Gross Profit on Sales... 


Selling Expense: 

Salaries of Selling Management. $6,099.12 

Salaries, Commissions, and Expenses of 

Salesmen. 128,650.42 

Advertising Expense. 12,033.28 

Free Goods. 33 ,428.14 

Traveling Expense of Sales Manager. 1,079.67 

Premiums.-. 1,954-86 

Stationery and Printing Consumed by Office 

of Sales Manager. 416.21 

Special Inducements to Jobbers. 2,100.95 

Salesmen’s Samples used in demonstration... 7,537-88 
Sundry Expense of Sales Office. 297.54 


Total Selling Expense 


392,366.88 


$ 344 , 359-54 


193 , 598.07 


Selling Profit 


$150,761.47 




























436 


FINANCIAL STATEMENTS 


Statement of Income —Continued 


Administrative and General Expenses: 

Administrative: 

Office Salaries. $17,462.91 

General Office Expenses and Supplies. 918.45 

Telephones and Telegrams. 153.16 

Legal Expense. 172.82 

Traveling Expense of Administrative Officers 900.00 

Postage Expense. 2,135.54 

Stationery and Printing—Office. 530-79 

Heat and Light—Office. 918.19 

Miscellaneous. 2,012.92 


$25,204.78 

General: -- 

Repairs and Maintenance of Buildings. $5,852.39 

Experimental Expense—Processes and New 

Goods. 2,888.49 

Experimental Expense—Machinery. 1,288.44 


$10,029.32 

Total Administrative and General Expense.. 

Profit from Operations . 

Additions to Income: 

Interest on Notes Receivable. 

Sundry Sales of Materials and Empty Con¬ 
tainers . 

Discounts Gained on Creditors’ Accounts 

(Cash Discounts).:. 

Interest on Bank Balances. 


Total Additions to Income. 

Total. 

Deductions from Income: 

Taxes, Licenses, and Fees. $2,627.86 

Fire Protection. 2,704.99 

Discounts Lost on Customers’ Accounts 

(Cash Discounts). 3,788.15 

Interest and Discounts—Notes Payable. 22,131.77 

Collection Fees and Other Bank Charges_ 71.05 


Total Deductions from Income 


$2.71 

1,480.57 

4,700.00 

112.10 


35,234.10 

$ 115 , 527.37 


6,295.38 
$121,8 22.75 


31,32382 


Gross Profit and Income from Operating and Other Sources $90,498.93 



































STATEMENT OF INCOME 


437 


Statement of Income— Continued 


Extraordinary Losses of the Period: 

Frozen Goods. $842.84 

Accounts Receivable—Uncollectable. 2,635.55 

Breakage of Carboys and Other Empty Con¬ 
tainers Returnable to Shippers. 254.77 


Total Extraordinary Losses of the Period. 3,733 .i6 


Net Profit for the Year Ended December 31, 1913 . $86,765.77 

Reserved: 

For Depreciation of Physical Assets. $9,481.39 

For Possible Losses of Accounts Receivable.. 2,715.34 


Total Reserved. 12,196.731 


Profit and Loss Surplus at December 31, 1913 . $74,569.04 

Surplus at January 1, 1913 . $171,368.31 


Less Adjustments during the Period: 

Returned Sales of prior periods, and Frozen 
Goods sold in prior periods, the profit on 
which figures in the surplus as established 
at January 1, 1913, including freight and 
all expenses paid by the Company on such 
returns. 8,652.33 


Net Adjusted Surplus, January 1, 1913. 162,715.98 


Surplus at January 1, 1914 (as per Balance Sheet of this 

Company given in the foregoing). $237,285.02 


Comment on the Statement 

If the internal anatomy of the statement varies at all, the 
variations are due, not to elasticity of the mechanism, but 
to differences of opinion as to the legitimacy of theories 
which establish the position to be occupied by individual 
facts. 

Some accountants claim that the income from sales is 
represented by the total of the charges to customers, less: 

i-a. The credits taken by them for returns, canceling 
the sales in part or in full 






















43 8 


FINANCIAL STATEMENTS 


b. Allowances given to them for shortages, injuries 

to goods, etc. 

c. Trade discounts 

2. All expenses which the vendor had agreed to stand 
in order to consummate the sale, such as the 
freight, cartage, and other possible delivery ex¬ 
penses to the point where the goods are to be 
delivered. 

Other accountants, on the other hand, while admitting 
items a, b, and c under i, deny that under any conditions 
freight and cartage, expressage, and delivery outward are 
anything but selling expense, or, in some cases, administra¬ 
tive expenses. 

Cash Discounts 

Economically speaking, cash discounts given and re¬ 
ceived measure the ability of the administration to give up 
part of the income from sales, in order that it may obtain a 
greater benefit in the settlement of its accounts payable. In 
other words, cash discounts given are considered as a 
financial bait intended to induce cash to flow in more readily 
than the terms of credit give the right to expect, in order 
that this cash may be used to take advantage of similar offers 
by creditors. It is said, however, that unless rates of dis¬ 
counts are obtained in a greater amount than they are given, 
discounts on both sides are useless. Many accountants, of 
course, refuse to consider cash discounts otherwise than 
as deductions from income from sales or from cost of goods. 

Cost of Goods 

The section of the statement which contains the cost of 
the goods sold is the one which gives rise to the widest 
differences of opinion. Speaking of the cost of manu¬ 
factured goods, some accountants claim that it is represented 
by: 


STATEMENT OF INCOME 


439 


1. Pre-process cost, i.e., freight inward, handling and 

store charges 

2. Material consumed 

3. Labor expended 

4. Manufacturing overhead applicable on some legiti¬ 

mate basis, and including, among'other items, re¬ 
pairs to machinery and tools and depreciation 
thereof 

5. General factory overhead applicable as above and 

including rent, actual or theoretical, of factory 
space, interest on capital invested in the factory, 
taxes on factory building, fire protection of the 
manufacturing property, etc. 

An equally positive group of accountants deny that de¬ 
preciation, being at best an estimate, can be charged to cost 
of goods which, supposed to be accurately positive, cannot 
afford to deal with estimates. They claim, further, that in¬ 
terest on the investment in physical assets necessary to the 
proper conduct of the business, is cost to the buyer of the 
goods, and is, as such, properly included in the sale price 
of the goods offered for sale, but is not cost of manufacture. 

Interest as an Element of Cost 

Among all these theories, the business man often loses 
his way; he reads a book on cost-finding advocating the in¬ 
clusion of interest and theoretical rent among the com¬ 
ponents of the cost of goods, and he adopts the theory, until 
it is pointed out to him that theoretical rent and theoretical 
interest, when added to cost, must be taken as income; that 
if the closing inventory is large, it is inflated by theoretical 
values which, reflected in the income, make him subject 
to a revenue tax greater by a certain percentage of the 
theoretical values than the amount which he would other¬ 
wise pay. Then, realizing that he has actually received 
neither rent nor interest, he is not quite so sure of the 


440 


FINANCIAL STATEMENTS 


infallibility of his author’s views. If proper appreciation of 
one’s welfare is able to settle the odious controversies into 
which accountants have been dragged concerning interest 
applicable to cost, the Federal Government should be 
thanked for taxing income. 

Book Increase of Cost 

It is undeniable that when the creation of a new depart¬ 
ment is contemplated by a business enterprise, and it is de¬ 
sired to compute the probable cost of the new departure, it 
is proper to include in the statistical computations every item 
which may represent a possible channel of outgo for capital; 
but much of the data thus marshaled is only statistical, 
and has no value as financial fact, when weighed upon the 
scales of actuality. We have all heard the argument to the 
effect that when a man goes into business he expects to 
secure a capital return at a rate which, after deduction 
therefrom of what his capital would produce if invested in 
securities, will appear fair to him. According to this, if an 
individual, by investing his wealth in a business enterprise, 
makes 10% on his investment, he has the right to say: “I 
could make 6 % by investing in bonds and mortgages; the 
difference is not worth my while.” With such an argument 
to defend his idleness a man would command little respect; 
and yet, by charging cost of goods with interest lost by 
investing wealth in capital assets, we end by reducing the 
gross profits on sales to a percentum which may lead to a 
disastrous conclusion. But the worst of it all is that, con¬ 
trary to the principle of business which states that with the 
efflux of years, carrying experience in its wake, the cost of 
manufacturing should steadily become smaller, the inclu¬ 
sion of theoretical interest in cost makes such cost climb 
upwards in direct ratio with the increase of physical assets. 
Thus, the more profits we reinvest in the business in a 
physical way, the more it costs us to manufacture. 


STATEMENT OF INCOME 


441 


In the example of the statement of income submitted 
above, taxes and fire protection have been treated as deduc¬ 
tions from income. This is in accordance with the tenets of 
the economic theory of income, which state that everything 
which one pays out for the protection of the capital repre¬ 
sented by physical assets, is equivalent to voluntary sharing 
of one’s income with some one else willing to give his serv¬ 
ices in return for proper compensation. 

Statement in Account Form 

The statement of income presented on pages 433-437 
could be prepared in account form instead of in report form 
without losing any of its value, lucidity, or analytical power. 
The truth of this assertion will be demonstrated by the 
following skeleton: 

The Black Diamond Manufacturing Company 
Profit and Loss Account 
For the Year Ended December 31, 1913 


Cost of Goods Sold.$. 

Gross Profit on Sales. 

Income from Sales: 

Sales. $. 

Less Deductions. 

$. 

Net Sales. $. 

Selling Expense. $. 

Selling Profits. 

Gross Profit on Sales 

(brought down). $. 

$. 

$. 

General and Administra- 

tive Expense. $. 

Profit from Operations. 

Selling Profits (brought 
down) . $. 

$. 

$. 











































442 


FINANCIAL STATEMENTS 


The Black Diamond Manufacturing Company 
Profit and Loss Account 
For the Year Ended December 31, 1913— Continued 


Deductions from Income $. 

Gross Profit and Income 
from operating and 
other sources. 

Profit from Operations 

(brought down). $. 

Additions to Income. 

$ . 

$ . 

Profit and Loss Debits.. $. 

Net Profit for the Period . 

Gross Profit and Income 
from operating and 
other sources (brought 

down) . $. 

Profit and Loss Credits. 

$ . 

$ . 

Appropriations for Re¬ 
serves . $. 

Profit and Loss Surplus 
for the Period. 

Net Profit for the Period 

(brought down).$. 

$ . 

$ . 


Surplus 


1913 

1913 

Dec. 31 Adjustments.... $. 

Jan. 1 Balance. $. 

Balance. 

Dec. 31 Adjustments . 


“ Profit and Loss.. 

$. 

$. 


Statement for Steam Roads Engaged in Interstate Traffic 

This statement is divided into two distinct sections, one 
for income and one for profit and loss. 

The income section has a skeleton of which the following 
are the most important parts: 
























































STATEMENT OF INCOME 


1. Railway Operating Income. $ 

2. Other Income . 


i plus 2 = Gross Income (or Loss). $ 

3. Deductions from Gross Income. 


Remainder is Net Income (or Loss). $ 

4. Disposition of Net Income. 


Remainder, transferred to debit or credit of Profit and 
Loss. $ 


The skeleton of the profit and loss section is as follows: 

Credits: 

Balance at beginning of fiscal period.$. 

1. Credit Balance transferred from Income Account. 


2. Profit on Road and Equipment Sold. 

3w Delayed Income Credits. 

4. Miscellaneous Credits. 

Balance carried to General Balance Sheet. $ 


Debits: 

Balance at beginning of fiscal period.....$ 


5. Debit Balance transferred from Income Account. 

6. Appropriations of Surplus to Sinking and Other Reserve 

Funds . 

7. Dividend Appropriations of Surplus. 

8. Appropriations of Surplus for additions and betterments.. . 

9. Appropriations of Surplus for new lines and extensions . 

10. Stock Discount extinguished through Surplus. 

11. Debt Discount extinguished through Surplus. 

12. Miscellaneous Appropriations of Surplus. 

13. Loss on Retired Road and Equipment. 

14. Delayed Income Debits. 

15. Miscellaneous Debits. 

Balance carried to General Balance Sheet. $ 


So far as the income statement is concerned, the first 
section is of great interest because it opposes: 

1. Rail operating revenues to rail operating expenses. 














































444 


FINANCIAL STATEMENTS 


2. Auxiliary operating revenues to auxiliary operating 
expenses, and adds the net result of the latter 
group of opposing items to the net result of the 
former group. 

Under the heading “Disposition of Net Income,” there 
are given: 

1. Appropriations of income for sinking and other re¬ 

demption funds 

2. Dividend appropriations of income 

3. Appropriations of income for additions and better¬ 

ments 

4. Appropriations of income for new lines and exten¬ 

sions 

5. Stock discount extinguished through income 

6. Miscellaneous appropriations of income 

It will be noted with interest that the requirements of 
the Interstate Commerce Commission demand a strict dif¬ 
ferentiation between income and surplus. It is to be hoped 
that American accountants, when presenting statements sup¬ 
posed to be analytical and enlightening, will have for the 
meanings of accounting facts, the respect which they de¬ 
serve. It is well enough for the majority of us to treat all 
transactions of a period which have resulted in a gain, a 
loss, a revenue expenditure, or an appropriation of profits, 
as debits or credits to the Profit and Loss account. It is 
also quite satisfactory to many that capital expenditures be 
recorded on the credit side of the account which produced 
the funds. But our statements too often fail to show that 
some losses and gains affect past profits undistributed; that 
some expenditures have been made out of current profits 
reinvested; that dividends have been declared out of current 
profits; that reserves of the past have been consumed during 
the current period. We are far too prone to treat a state¬ 
ment of results as an accumulation of figures which must 


STATEMENT OF INCOME 


445 


balance “by hook or by crook” and are too willing to in¬ 
trench ourselves behind our supposed mastery of a science 
the very elements of which we do not always know. 

Statement of Cash Receipts and Disbursements 

Many accountants believe that this statement is merely 
a recital, more or less logical, of the cash transactions of the 
period; and still a greater number believe that it is a use¬ 
less duplication of figures given in full detail by the cash 
book. And yet, it is more than true that the cash book 
carries forward no individual amount of prior transactions; 
that few cash books can be provided with enough columns 
to give a clear idea of the transactions which they record, 
and that a clear and purposeful resume of the all-important 
cash transactions of a given period may be as interesting 
to the officers of a concern as the other financial statements 
presented. To illustrate this point the statement of cash 
receipts and cash disbursements of the Black Diamond 
Manufacturing Company, for the six months ended Decem¬ 
ber 31, 1913, is given below : 

Black Diamond Manufacturing Company 


Statement of Cash Receipts and Disbursements 

Debits—Cash Received: 

1. From the Collection of Current Assets: 

Customers’ Accounts. $366,487.14 

Claims against Transportation Companies 2,183.93 
Notes and Loans Receivable, and Interest 
thereon. 1,427.49 $370,098.56 


2. From the Sale of Working Assets: 

Materials and Supplies Sold to Employees $59.01 

Carboys and Empty Containers. 1,000.00 1,059.01 


3. From the Incurrence of Liabilities: 

Notes and Loans Payable. $153,016.34 

Deposits by Employees. 15.00 

Credit Accounts of Oliicers... 2,106.10 155,137.44 











446 


FINANCIAL STATEMENTS 


Cash Receipts and Disbursements— Continued 


4. From Miscellaneous Sources: 

Fire Insurance Premiums Refunded. $10.05 

Dividends on Mutual Fire Policies. 364.38 

Refunds by Creditors, for overpayments 
and allowances not deductible from bills 6.15 


5. Total Receipts for Period_ 

6. Balance on Hand, July 1, 1913 

7. Total Debits. 


Credits—Cash Disbursed: 

1. For Liabilities Liquidated: 

To Creditors. $171,350.29 

“ Employees—for Wages. 42,650.19 

“ Banks for Loans and Notes. 177,589.99 


“ Mortgagee—for Reduction of Mortgage 19,000.00 


2. To Interest on Indebtedness. 

3. For Reduction of Credit Accounts of Officers. 

4. For Pre-Process Cost of Goods Manufactured: 

Freight and Cartage Inward and Handling Charge... 


5. For Factory Overhead Expenses: 

Automobile Expense. $317.80 

Warehouse Charges and Cartage. 40.25 

General Expense of Factory. 150.05 

Miscellaneous Shipping Expense. 1,040.65 


6. For Selling Expenses: 

Salaries and Commissions of Salesmen... $58,115.40 

Advertising Expense. 10,251.53 

Special Commissions to Jobbers. 222.66 


7. For General and Administration Expense: 

Salaries. $12,000.00 

Postage Expense. 1,398.89 

Telephone and Telegrams. 93.06 

Traveling Expense of Officers. 450.06 

Legal Expense. 1,027.59 

Miscellaneous Expense. 31-42 


8. Total Cash Disbursements for Period 

9. Balance on Hand, December 31, 1913. 


380.58 


526,675.59 

7 , 643.05 


$534,318.64 


$410,590.47 

6,251.07 

9,680.15 

3,882.44 

1 , 548.75 


68,589.59 


15,003.02 

«r 

515,54549 

18 , 773.15 


IO. Total Credits 


$ 534 , 318.64 








































CHAPTER XXXVIII 


THE CONSOLIDATED BALANCE SHEET 

“Consolidation” and “Consolidated” Balance Sheets 

When it is desired to gather together the assets and 
the liabilities of several companies which it is proposed to 
consolidate, the resulting balance sheet is called a “Con¬ 
solidation of the Balance Sheets of Companies A, B, C,” 
etc., at a given date. The process is very simple, consist¬ 
ing merely in expressing in one amount the assets and 
the liabilities of the various units. Thus, if Companies 
A, B, and C have a capital stock of $1,000,000 each, the 
capital stock of the three companies together is given as 
$3,000,000. The object of such a balance sheet is to show: 

1. The assets which will enter the combination. 

2. The liabilities to be liquidated out of them. 

3. The total equity of the stockholders taken as a 

whole, in order that the probable amount of the 
new capital stock to be issued if the consolida¬ 
tion takes place, may be estimated. 

In contradistinction, the term “consolidated” is made 
to apply to balance sheets which attempt to show to the 
owners of the stock of a company holding the stock of 
others, the exact status of the assets which they control, 
and of the liabilities to be met out of the assets. 

The purpose of holding companies is to acquire the 
control of the stock of operating companies and to receive 
as their income the income of these companies. It is 

447 


448 


FINANCIAL STATEMENTS 


plain, of course, that behind the financing scheme there 
lies an internal organization created with the object of 
reducing, through systematic and enlightened manage¬ 
ment, the cost of operating the controlled companies. It 
is also evident that, in principle, the financing of a weak 
member of the community of components, can be attended 
to much more economically through internal channels 
than it can by means of outside assistance. Thus, it is not 
infrequent to find on the balance sheet of a controlled 
company an asset which is the liability of another con¬ 
trolled company. The situation created by such internal 
financing, while not in the least peculiar, is interesting 
because it raises the question of accounting by offsets. 

If a father had intrusted the management of $300,000 
of personal property to three of his sons, in equal amount, 
they to enjoy the income of the trust, it might be that, 
at the end of a given period, the marshaling of the units 
of the principal of the trust fund might show that John 
had loaned $50,000 to James, who in turn had loaned 
$25,000 to Charles. But the balance sheets submitted by 
the three trustees would not in the aggregate reveal any¬ 
thing of great importance to the father, since the fund 
remains intact. If James repaid John the $50,000 which 
he owes him, and, in turn, Charles repaid to James the 
$25,000 loaned by the latter, John’s balance sheet would 
be richer in liquid assets, while that of James and Charles 
would be poorer in liquid assets and richer in reduction 
of liabilities; but the father would not have one cent more. 

If, then, the components of a holding company, as 
represented by the stock which the latter controls, have 
been financed one by the other, all the debts of an indi¬ 
vidual member which are the assets of another member 
must be omitted from a statement endeavoring to show 
the exact status of the assets controlled by the parent 
company. 


THE CONSOLIDATED BALANCE SHEET 


449 


Form of Consolidated Balance Sheet 

The following problem taken from the New York 
C.P.A. examination of January, 1913, is brought in as a 
basis for the preparation of a consolidated balance sheet: 

Company C was incorporated in May, 1910, to acquire 
the stock of Companies A and B. Company C’s capital 
stock is divided into preferred, $2,500,000, common, 
$1,500,000; all the stock is outstanding and fully paid; 
it has been issued (1) for stock to the stockholders of 
Companies A and B, (2) $20,000 of preferred for organiza¬ 
tion expenses, (3) for cash. The stockholders of A and B 
received preferred stock for the intrinsic, undepreciated 
book value of the assets, as reflected by the following 
balance sheets of their companies at June 30, 1910, and 
$300,000 of common stock divisible equally between Com¬ 
panies A and B. 

Assets 


Plant Land. 

$90,000 

$195,000 

Building and Equipment. 


318,000 

Machinery and Tools. 

228,600 

276,800 

Transportation Equipment. 


17,000 

Tnvpstmpnt in T.and. 


150,000 

Tmrpcfmpnt in Unnrlt;—On B.. 

.. 60,000 

T mrpctmpnf *~itnrl< r Q.. 

.. 200,000 


Goods in Process. 


49 , 34 i 

Finished Goods. 

69,000 

76,340 

Material and Supplies.;. 


5 L 300 

f ash ..., T .. 


I 9 U 75 

Accounts Receivable. 


92,800 


5,000 


A r*r*rnprl TnfprPQt.. . . . . . ... # • • • 




$1,100,820 

$1,245,756 

Liabilities 



Capital Stock Outstanding: 





$1,000,000 




6% Bonds, 1915, J. & J. and Interest Accrued.. 


92,700 































45° 


FINANCIAL STATEMENTS 


Liabilities—Continued 


Accounts Payable. 59,800 4L656 

Loans Payable. 65,800 35,000 

Audited Vouchers Unpaid. 18,320 I 3 > 4 00 

Demand Notes Payable. 5>ooo 

Reserve for Depreciation. 24,900 30,000 

Reserve for Doubtful Accounts. 5 > 000 2,000 

Reserve for Contingencies. 16,000 . 

Surplus . 111,000 26,000 


$1,100,820 $1,245,756 

Between July 1 and July 31, 1910, the following 
transactions occurred: organization expenses paid in cash 
by Company C, $5,000; intercompany advances by C: to 
A, $60,000; to B, $60,000; Company A reduced its ac¬ 
counts payable by $25,000; its loans payable by $30,000 
and its audited vouchers by $15,000; Company B reduced 
its accounts payable by $29,500, liquidated its audited 
vouchers unpaid and its interest due under the bonds. 

The manufacturing operations of the period show: 
Company A—labor, $10,000; overhead expenses, $8,000; 
materials consumed, $9,886; inventory of goods in process, 
$46,300; of finished goods, $50,740; selling expenses paid, 
$1,600; administration expenses, $2,500; sales, $72,500; 
collections of open accounts, $86,400. Company B— 
labor, $3,600; overhead, $2,350; materials, $5,210; inven¬ 
tory of goods in process, $40,500; of finished goods, 
$46,380; sales, $98,000; collections, $109,150; administra¬ 
tion expenses, $3,000.75; selling expenses, $1,040. 

No materials were purchased during the period and 
the current expenses were paid as soon as the invoices 
were audited. Company A declared a dividend of $100,000 
and Company B a dividend of $25,000. 

Prepare the consolidated balance sheet of Companies 
A and B and C, at July 31, 1910, to be submitted to the 
directors of Company C and so arranged as to show them 
the exact detail of the properties that they control. 


















THE CONSOLIDATED BALANCE SHEET 


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THE CONSOLIDATED BALANCE SHEET 


453 


Formation of Consolidated Balance Sheet 

A discussion of the foregoing solution will be sufficient 
to clear up the supposed intricacies of the consolidated 
balance sheet. Before proceeding, however, it may be 
well to present the ledger accounts of the three companies, 
built up from the facts given by the text of the problem. 
These are given in order to show how the closing facts are 
obtained. 


Ledger Accounts 
Company A 
Cash 


Balance. 

. $17,420.00 

Accounts Payable... 


Company C. 

. 60,000.00 

Loans Payable. 


Accounts Receivable.. 

. 86,400.00 

Audited Vouchers... 


Interest on Bonds. 

1,800.00 

Labor . 




Factory Expense.... 




Selling . 




Administration Expense 2,500.00 



Balance. 

• • • 73,520.00 


$165,620.00 

* 

$165,620.00 

Balance. 

• $73,520.00 




Goods in Process 


Balance.$45,000.00 

Materials and Supplies.. 9,886.00 

Cash—Labor. 10,000.00 

Cash—Factory Expense 8,000.00 


$72,886.00 


$46,300.00 


Finished Goods. $26,586.00 

Inventory. 46,300.00 


$72,886.00 


Balance 































454 


FINANCIAL STATEMENTS 


Profit and Loss 


Finished Goods. 

$44,846.00 

Sales. 


Selling Expense. 

600.00 

Interest on Bonds.... 


Administration Expense 

2,500.00 



Surplus . 

23,85400 




$72,800.00 


$72,800.00 


Finished Goods 


Goods in Process... 
Balance . 


Inventory . 

Profit and Loss.... 

-$50,740.00 


$95,586.00 


$95,586.00 


Surplus 


Dividends . 

.$100,000.00 

Balance . 


Balance . 

. 34,85400 

Profit and Loss.... 

- 23,854.00 


$134,854.00 


$134,854.00 



Balance . 

.... $34,854.00 


Company B 

Cash 


Balance . $19,175.00 

Company C. 60,000.00 

Accounts Receivable.... 109,150.00 


$188,325.00 


$132,734.25 


Accounts Payable.. 


Audited Vouchers. 


Interest on Bonds.. 


Labor . 


Factory Expense.. . 

- 2,350.00 

Selling . 


Administration 

Ex- 

penses . 


Balance . 



$188,325.00 


Balance 



















































THE CONSOLIDATED BALANCE SHEET 


455 


Goods in Process 


Balance. 

$49,341.00 

Finished Goods. 


Materials and Supplies. 

5,210.00 

Inventory .„.. 


Cash—Labor. 

3,600.00 

r 


Cash—Factory Expense 

2,350.00 



$60,501.00 


$60,501.00 

Balance. 

$40,500.00 




Profit and Loss 


Finished Goods. 

$49,961.00 

Sales. 


Selling Expense. 

1,040.00 



Administration Expense 

3,000.75 



Interest on Bonds. 

450.00 



Surplus. 

43 , 548.25 




$98,000.00 


$98,000.00 


Finished Goods 


Goods in Process... 
Balance. 


Inventory . 

Profit and Loss.... 



$96,341.00 


$96,341.00 


Surplus 


Dividends . 

Balance. 

.$25,000.00 

Balance. 

Profit and Loss.... 

.... 43 , 548.75 


$69,548.25 


$69,548.25 












































456 


FINANCIAL STATEMENTS 


Company C 

Cash 


Preferred 

Capital 

Advances . 


Stock .. 


Organization Expenses 5,000.00 

Common Capital Stock 1,200,000.00 

Balance. 



$1,665,100.00 


$1,665,100.00 

Balance .. 





Capital Stock—Preferred 


Preferred Capital 

Stock Authorized. .$2,500,000.00 

Investment in Stocks. 
Investment in Stocks. 
Organization Expenses 
Cash. 

$956,900.00 

1,058,000.00 

20,000.00 

465,100.00 

$2,500,000.00 

$2,500,000.00 


Capital Stock—Common 


Common Capital Stock 

Authorized.$1,500,000.00 

Investment in Stocks. $300,000.00 
Cash. 1,200,000.00 

$1,500,000.00 

$1,500,000.00 


Investments in Stocks of Other Companies 


Preferred Capital 

Stock. $956,900.00 

Preferred Capital 

Stock. 1,058,000.00 

Common Capital Stock 300,000.00 

Balance.$2,314,900.00 

$2,314,900.00 

$2,314,900.00 

Balance.$2,314,900.00 






































THE CONSOLIDATED BALANCE SHEET 


457 

The points of interest in the foregoing problem appear 
to be: 

1. The amount of cash which has been obtained by 
Company C through the issue of stock is not given; and 
since the amount of stock issued by C in exchange for the 
capital stock of A and B is not mentioned, the accurate 
building up of the cash account of C depends upon the 
understanding of what constitutes “intrinsic, undepre¬ 
ciated book value of the assets.” 

2. The good-will which, so far as C is concerned, repre¬ 
sents the difference between the intrinsic book value of 
the assets and the price paid for the stock of A and B, i.e., 
$300,000, will have to be expressed in the consolidated 
balance sheet at a figure which can be obtained only from 
careful consideration of its components. 

3. All the intercompany holdings will have to be 
eliminated from the consolidation, upon the ground that 
this exclusion will not in any way alter the status of a 
single one of the assets of A and B controlled by C. If 
this test cannot be applied to a proposed elimination, it 
should not be made. 

1. The Amount of the Issues of Stock for Cash. The 
term “intrinsic, undepreciated book value” means all the 
assets of A and B, as appearing on the balance sheets 
submitted, less their liabilities to outsiders, no cognizance 
whatever being taken of the reserves. Thus, since the 
intrinsic, undepreciated book value of the assets of A and 
B is in the aggregate $2,014,900, this amount of preferred 
stock was issued by C to the stockholders of A and B. 
Further, if $20,000 of the same stock was issued for organ¬ 
ization expense, the company must have received $465,100 
in cash for the balance. As to the common stock, it is 
plain that the price paid in stock by Company C for the 
excess of cost over intrinsic value being $300,000, the 


FINANCIAL STATEMENTS 


458 

balance of the authorization, i.e., $1,200,000, was issued 

for cash. 

2. The Component Parts of the Good-Will. 

The assets of A and B, as appearing in the balance sheets of 
these two companies at June 30, 1910, aggregate. $2,346,576.00 

Deducting from this figure the amount which has been ac¬ 
quired through the use of credit, i.e., through the in¬ 
currence of liabilities to outsiders. 331,676.00 


We obtain an amount of.$2,014,900.00 

Which represents, according to principles of accounting... 1,800,000.00 
of assets acquired through the use of the capital con¬ 
tributions of the stockholders, as evidenced by the capital 
stock liabilities of the two companies. 


Deducting the capital stock we have a remainder of. $214,900.00 


which cannot be anything else than the assets acquired by 
companies A and B through the reinvestment of their 


undivided profits of prior periods, as measured by: 

1. The surplus available for dividends. $137,000.00 

2. The surplus appropriated for the purpose of reserves.. 77,900.00 


$214,900.00 


Thus we have found two of the components of the 
good-will acquired by Company C. As to the third, it 
must of necessity be the $300,000 of common stock issued 
by C in excess of the intrinsic value of the assets of A and 
B. To prove that the resulting figure of $514,900, which 
is called good-will on the consolidated balance sheet sub¬ 
mitted above, is truly what it pretends to be, let us assume 
that, instead of expressing its investment in stocks of 
other companies at cost, as appears to have been done, 
Company C had expressed it at the par of the stocks 
acquired. The journal entry, under these circumstances, 
would have been: 












THE CONSOLIDATED BALANCE SHEET 


459 


Investment in Stocks of Other Companies... $1,800,000.00 


Good-Will. 514,900.00 

To Capital Stock—Preferred. $2,014,900.00 

Capital Stock—Common. 300,000.00 


For acquisition of the stock of companies 

A and B, the good-will being represented 

by: 

1. Undivided profits.$137,000.00 

2. Appropriations of surplus 77,900.00 

3. The good-will value of the 

investment covers the 
intrinsic value of the 
assets acquired. 300,000.00 

$514,900.00 

3. The Eliminations. Irrespective of their importance 
to Companies A and B in their capacity as separate enti¬ 
ties, the debts of A to B and of B to A are nothing to C, 
who owns the stock of both. It is plain that if, for instance, 
the demand notes held by A against B were to be repaid 
by the latter, A would have more cash, and less claims 
against other companies, while B would have less cash, 
and a lesser amount of liabilities to outsiders. But it is 
also evident that the consolidation of the cash account 
of A, B, and C would give a figure absolutely identical 
with the one shown in the balance sheet, i.e., $1,746,354.25, 
which is the true extent of C’s control of available cash. 
If the same reasoning is applied to any one of the elimina¬ 
tions shown in the above solution, the same result will be 
obtained. 

The investment in stocks of other companies as carried 
by C in its balance sheet, must be eliminated because, in¬ 
stead of expressing the amount of the investment, it is 
required that the assets which it controls, subject to 
whatever liabilities attach to them, be expressed in detail. 
The elimination of the capital stock of Companies A and B 








460 


FINANCIAL STATEMENTS 


•is indicated by logic. If the said stock originally con¬ 
trolled the assets of A and B, and has since been replaced 
by the stock of C, it is only the latter which controls the 
assets; the former is a nonentity to C for purposes of a 
consolidated balance sheet. It represents only docu¬ 
mentary evidence of the transfer of the assets which were 
originally acquired out of it. 


CHAPTER XXXIX 


THE STATEMENT OF AFFAIRS 
Appointment of Receivers 

The term ‘‘financial embarrassment” suggests to 
many people the state of insolvency and consequent re¬ 
ceivership. And yet the appointment of receivers by 
courts of equity is looked upon as an extreme measure, 
only to be resorted to when the courts are convinced that 
such action is essential to secure properties from waste 
pending readjustment of finances or eventual liquidation. 
As a matter of law, no receiver is appointed unless the 
referee in the case has found: 

1. That the plaintiff has some right or lien upon the 

properties at issue. 

2. That in principle he has a legal right to consider 

the property as a fund to be devoted to the 
satisfaction of his claim, or 

3. That the respondent has fraudulently entered into 

possession of the thing in litigation, or 

4. That insolvency is so evident that the assets are 

in serious danger of being lost through sheer 
waste, to the prejudice of the creditors. 

Status of the Statement of Affairs 

To the student of accountancy, the statement of affairs 
is essentially a receiver’s statement. As a matter of fact, 
neither the receiver nor the assignee is permitted by New 
York courts to file such a statement. 

461 


462 


FINANCIAL STATEMENTS 


A receiver may, upon being appointed, ask an account¬ 
ant to prepare for him a statement showing what are the 
assets of the concern whose affairs he is to administer, and 
to what classes of liabilities they are subject; he may fur¬ 
ther wish to know, as soon as possible, the probable 
amount of the free assets of which he will dispose for the 
settlement of unsecured claims. But what is more prob¬ 
able, he will ask for a list of all the assets and of all the 
liabilities as they stand on the books. Then he will have 
the assets appraised; he will ask through the courts that 
all creditors prove their claims and, within a reasonable 
time, he will file the lists. Subsequently, he will keep such 
accounts as will permit him to show what he collected on 
the said assets, and what he paid on the liabilities, as filed. 

Thus, so far as the receiver is concerned, the “state¬ 
ment of affairs/’ which has assumed such importance in 
C.P.A. examinations, is essentially theoretical. If it has 
any value at all, it is in other directions. 

A concern whose finances have been badly managed 
may, while actually prosperous if judged by the standard 
of profits, be compelled to throw itself on the mercy of 
its creditors for extension of time, or for further credit. 
Before granting the request, the creditors may ask that a 
clear insight be given them as to: 

1. The financial status of the concern if liquidation 

of its affairs is deemed advisable. 

2. The causes of the conditions which make further 

credit necessary. 

3. The marshaling of the losses so as to show which 

are due to mismanagement and which to un¬ 
profitable trading conditions, and what losses 
will be incurred by a forced liquidation, if such 
a drastic action is contemplated. 

Thus understood, the theoretical statement of affairs 
assumes proportions which make it a valuable document 


THE STATEMENT OF AFFAIRS 


463 

in the hands of creditors, be they laymen or financial 
institutions. In truth, the statement has no power other 
than that which it borrows from the power of logic and 
accounting analysis of the one who prepares it and draws 
proper conclusions from the arrangement of its otherwise 
meaningless results in a deficiency account. 

Asset Side of Statement 

The theoretical form of the statement of affairs is shown 
on pages 464, 465. 

In the form as given the division of the space for 
“Estimated to Realize” into two columns, is to facilitate 
the deduction of liabilities from assets, or assets from 
liabilities, as explained below, and as illustrated by the 
solution of the New York C. P. A. problem given on page 

469. 

The theoretical skeleton of the account is as follows: 

1. State the assets in the probable order of their 
realization. 

2. Deduct from the appraised value of pledged assets, 
the amount of the liabilities which they secure in full. 

3. Deduct the appraised value of assets partially se¬ 
curing liabilities, from the liabilities to which they are 
pledged. 

4. Total the remainder of the appraised value of the 
assets. 

Liability Side of Statement 

1. State the liabilities at the value at which they stand 
on the books, classifying them as follows: 

a. Unsecured Claims 

b. Fully Secured Claims 

c. Partially Secured Claims 

d. Preferred Claims 


464 


FINANCIAL STATEMENTS 







Figure 41a . Form of Statement of Affairs and Deficiency Account (Asset Side) 




















































THE STATEMENT OF AFFAIRS 




Figure 41b. Form of Statement of Affairs and Deficiency Account (Liability Side) 








































466 


FINANCIAL STATEMENTS 


2. Deduct the fully secured claims from the assets 
which are pledged to them. 

3. Deduct the appraised value of assets partially se¬ 
curing liabilities from the liabilities to which they are 
pledged, and extend the remainder as unsecured 

4. Deduct the preferred claims from the remainder of 
the appraised value of the assets as shown by the second 
column of the space headed “Estimated to Realize.” 

5. Total the unsecured claims as extended in the 
second column of the space headed “Expected to Rank.” 

Bring the statement to a close by establishing either 
on the asset side, or on the liability side: 

1. The amount by which the liabilities unsecured ex¬ 

ceed the remainder of free assets, at their 
appraised value; or 

2. The amount by which the remainder of free assets 

exceeds the unsecured liabilities. 

Preparation of Statement of Affairs 

The solution of the following problem taken from the 
New York C.P.A. examination of January, 1912, will 
illustrate further the theory of the statement of affairs 
and the deficiency account, and also the method of their 
preparation. 


Problem 

Under pressure of financial difficulties the General 
Contracting Company has applied to its creditors for ex¬ 
tension of credit. The creditors’ committee has engaged 
accountants to examine the books, and appraisers to 
appraise the physical property of the company. The 
examiners and appraisers are given, as a basis for their 
work, the following balance sheet, prepared by the com¬ 
pany’s bookkeeper June 30, 1911: 


THE STATEMENT OF AFFAIRS 


Debits 

Plant and Equipment_ $150,000 


Horse, Wagon and Har¬ 
ness . 3,000 

Machinery and Tools... 110,000 

Shop and Hand Tools.. 17,000 

Materials and Supplies.. 38,000 

Finished Goods. 5,675 

Uncompleted Contracts.. 72,300 

Cash . 48,800 

Accounts Receivable. 11,150 

Notes Receivable. 15,000 

Accrued Interest on 

Notes Receivable. 530 

Stationery and Printing.. 1,220 

Unexpired Insurance.... 280 


$472,955 


467 


Credits 

Capital Stock Authorized 

and Outstanding.$100,000 

Bond and Mortgage Pay¬ 
able, 6%, due Jan. 1, 

1912 . 85,000 

Notes Payable. 35,000 

Audited Vouchers Un¬ 
paid . 156,000 

Uncompleted Contracts, 

Instalments. 45,000 

Dividend No. 6 Payable. 5,000 

Wages Accrued. 2,650 

Interest Accrued on Bond 
and Mortgage Payable 425 

Interest Accrued on 

Notes Payable. 470 

Reserve for Plant and 

Plant Equipment. 6,000 

Reserve for Machinery 

and Machine Tools- 5,400 

Reserve for Shop and 

Hand Tools. 1,500 

Reserve for Horse, 

Wagon and Harness.. 1,450 

Reserve for Contract 

Contingencies . 5,200 

Surplus. 23,860 


$472,955 


In due time the accountants render a report which, 
among- other things, contains the following remarks: 

“The account ‘Finished Goods’ represents the inven¬ 
tory, at cost, of certain machines built under contract 
during the six months of the present accounting period 
ended June 30, 1911, which the other contracting parties 
decline to accept, owing to flaws and violations of speci¬ 
fications. The accounts receivable are made up as fol¬ 
lows: (a) subject to bona fide and admittedly reasonable 
claims by customers, for unsatisfactory goods manufac- 




























468 


FINANCIAL STATEMENTS 


tured under contract during prior period, $3,600; (b) last 
instalment due this company under contracts of the prior 
period, completed and delivered, $7,550; the aggregate 
amount of these instalments is due August 1, 1911, but is 
subject to certain guarantees which have subjected the 
company to fines of $1,500 on account of defective work; 
these fines will be deducted from the instalments when 
due; the balance of the amount of $7,550 will be collected 
in due time. The account ‘Uncompleted Contracts, In¬ 
stalments,’ represents amounts paid by customers during 
June, 1911, on certain contracts reaching a specific stage 
of development. The unexpired insurance premiums 
would, if the policies were canceled, produce $160. There 
exists no liability for discounted notes. The notes re¬ 
ceivable on hand are indorsed by responsible parties.” 

The appraisers report as follows: 

“The physical assets of the company, as appraised by 
us, would produce at forced sale: plant and plant equip¬ 
ment, $90,000; machinery and tools, $55,000; shop and 
hand tools, $5,000; horse, wagon and harness, $1,000. 
The uncompleted contracts would require, to carry them 
to completion, an expenditure of the following: material, 
$10,000; labor, $7,000; factory overhead, $3,000, irrespec¬ 
tive of general overhead. We are informed by the surety 
company, who have guaranteed the completion of the 
contracts, that it will undertake to complete them pro¬ 
vided this company will sell them for $9,000, the amount 
of materials which we have estimated to be necessary for 
completion, and provided further, that this company will 
accept in settlement the cost to it of the contracts as they 
stand on its books at June 30, 1911, with 4% of the said 
amount added for profits. The balance of the materials 
and supplies would produce $20,000. The finished goods 
are worth only their scrap value, i.e., $250. The station¬ 
ery and printing is worth $10.” 


THE STATEMENT OF AFFAIRS 


469 

The books of the company show that the contracts in 
process will, when completed, produce $130,000. 

From the above facts prepare: 

1. Statement of affairs at June 30, 1911. 

2. Deficiency account that will account logically for 

the losses incurred by the company and by 
its creditors under the assumption that the cred¬ 
itors are considering favorably the dissolution 
of the company and the completion of the con¬ 
tracts by the guarantors. 


Solution 

Statement of Affairs 

Assets 

Book Value Estimated to Realize 


Cash . 

Accounts Receivable: 

Good. 

Uncollectable. 

Notes Receivable. 

Accrued Interest on Notes Receiv¬ 
able . 

Stationery and Printing. 

Unexpired Insurance Premiums... 
Plant and Plant Equipment (re¬ 
serve for depreciation deducted) 

Less Bond and Mortgage Payable: 

Principal .$85,000.00 

Interest . 425.00 


$48,800.00 


$48,800.00 

6,050.00 

5,100.00 

15,000.00 


6,050.00 


15,000.00 

530.oo 


530.00 

1,220.00 


10.00 

280.00 


160.00 

144,000.00 

$90,000.00 



85,425.00 

4 , 575 -oo 


Horse, Wagon and Harness (re¬ 


serve for depreciation deducted) 1,550.00 

Machinery and Tools. 104,600.00 

Shop and Hand Tools. 15,500.00 

Materials and Supplies: 

To be sold to the Surety Company 10,000.00 
Balance remaining in store. 28,000.00 


1,000.00 

55,000.00 

5,000.00 


9,000.00 

20,000.00 

































470 


FINANCIAL STATEMENTS 


Statement of Affairs— Continued 


Finished Goods. 

Uncompleted Contracts. 

Less Instalments collected there¬ 
under . 

Total. 

Deduct Preferred Claims: 

Wages Accrued. 

Balance available for distribution to 
unsecured creditors, being 98.19% 
of their claims, subject to ex¬ 
penses incident to realization and 

liquidation. 

Deficiency, as per Account. 

Total. 


Book Value Estimated to Realize 


$5,675.00 . $250.00 

72,300.00 $75,192.00* . 

. 45,000.00 30,192.00 

$458,605.00 $i95»567-0O 


2,650.00 


$192,917.00 

3,553-00 


$196,470.00 


Liabilities 


Unsecured Claims: As Per Books 

Notes Payable: 

Principal . $35,000.00 

Interest . 470.00 

Audited Vouchers Unpaid. 156,000.00 

Dividends Payable. 5,000.00 

Fully Secured Claims: 


Bond and Mortgage Payable: 

Principal . $85,000.00 

Interest . 425.00 85,425.00 


Expected to Rank 


$35,000.00 

470.00 

156,000.00 

5,000.00 


Deducted from estimated amount 
to be realized on property pledged . $85,425.00 

Partially Secured Claims (None) 

Preferred Claims: 

Wages Accrued. 2,650.00 . 

Deducted from remainder of free 
assets estimated to be realized. 2,650.00 


*= Cost + 4% 










































THE STATEMENT OF AFFAIRS 


471 


Statement of Affairs— Continued 
Uncompleted Contracts: As Per Books Expected to Rank 


Received in Cash.. 

Instalments received in cash, de¬ 
ducted from the amount to be 
realized on such contracts. 

Reserves, Capital and Surplus: 
Reserves for Contract Contingencies 

Capital Stock. 

Surplus. 

Total Book Liabilities, Capital and 
Surplus. 

Total Deducted from Assets. 

Total Unsecured Claims. 


$45,000.00 . 

. $45,000.00 

5,200.00 . 

100,000.00 . 

23,860.00 . 


$458,605.00 


$133,075-00 


$196,470.00 


Preparation of Deficiency Account 

From the foregoing facts, supported by the analysis 
of the accounts and by the appraised valuation of certain 
assets, the following deficiency account is established: 


Deficiency Account 


Estimated Losses: 

1. On Realization of Assets: 

Plant and Plant 

Equipment . $54,000.00 

Horse. Wagon and 

Harness . 550.00 

Machinery and Ma¬ 
chine Tools. 49,600.00 

Shop and Hand Tools 10,500.00 
Materials and Sup¬ 
plies . 9,000.00 


Total.$123,650.00 


Net Loss, to be sustained by: 

1. Unsecured Creditors: 

Deficiency, as per 

statement . $3,553.00 

2. Stockholders: 

Capital Stock Out¬ 
standing . 100,000.00 

Surplus: 

As per 

books. $23,860.00 
Add: 

Transfer of bal 
ance of Reserve 
for Contract 

Contingencies. .100.00 23,960.00 


2. Incident to Realization 
and Liquidation : 

Stationery and Print¬ 
ing . $1,210.00 

Insurance Premiums 
deferred from 
prior periods. 120.00 

Total. $1,330.00 














































472 


FINANCIAL STATEMENTS 


Deficiency Account— Continued 


Total Losses Due to or 
Incident to Realization 
and Liquidation.$124,980.00 


Operating Losses: 

Defective goods manu¬ 
factured during this 
period, under con- 
tract, rejected by 
customers: 

Cost .$5,675.00 

Less esti- 
mated 

scrap value 250.00 $5,425.00 


Less operating gains, 

4% on cost of con¬ 
tracts, offered by the 
Surety Co. 2,892.00 


$2,533.00 

Loss of Appropriated Surplus: 

Fines incurred 
for viola- 
t i o n s of 
specifica¬ 
tions under 
contracts ..$1,500.00 
Allowances to 
customers 
for claims 
under con¬ 
tracts . 3,600.00 


Total. .$5,100.00 

Less Reserve 
for Contract 
Conti ngen- 
cies. 5,100.00 


Total Losses... .$127,513.00 


$127,513.00 


Treatment of Reserves 

The treatment of reserves in the statement of affairs 
and in the deficiency account is twofold: 

1. Reserves may be deducted from the book value of 
the assets in order that the remainder, or depreciated book 
value, when compared with the estimated realization may 
give the amount of the true loss not provided for. 

2. Reserves may be treated on the liability side of the 
statement as appropriated surplus, and deducted in the 
deficiency account from the estimated losses said to be 
due to forced liquidation. 




















THE STATEMENT OF AFFAIRS 


473 


Arrangement of the Statement of Affairs 

The arrangement of the statement is, of course, a 
matter of personal opinion, since we are dealing with 
theory not consecrated by practice. 

1. The assets may be shown on the debit side or on 
the credit side of the statement. 

2. The statement may start with a perfect balance by 
showing in the “Book Value” column all the open ac¬ 
counts, debits and credits, found in the general ledger; 
or it may treat only of assets which are to be realized, and 
of liabilities to outsiders. 

3. It may present the liabilities in the order given in 
the above solution, or it may state them in the order pre¬ 
scribed by the summary of debts and assets to be pre¬ 
sented by bankruptcy petitioners; i.e.: 

1. Preferred Claims 

2. Secured Claims 

3. Unsecured Claims 

4. Contingent Liabilities 

5. Accommodation Paper 

Arrangement of Deficiency Account 

As to the deficiency account, any arrangement which 
fails to bring it down to the level of accounting under¬ 
standing possessed by the average layman, and requires 
expert explanation for its clear comprehension, is to be 
condemned whether we deal with theory or with practice. 

If the statement of affairs ends with an excess of free 
assets over and above the amount of unsecured claims, 
the deficiency account can still be made; but, instead of 
showing deficiency to meet the claims of outsiders, it is 
satisfactory to show that deficiency which measures the 
impairment of the capital of the insiders, be they sole 
traders, copartners, or stockholders. 


CHAPTER XL 


REALIZATION AND LIQUIDATION 

Method of Closing 

Concerns in voluntary liquidation close their books in 
the usual manner. As the assets are collected the amount 
of the proceeds is debited to cash and credited to the 
assets. Excess or deficiency of proceeds is credited or 
debited to the surplus to be distributed to the stock¬ 
holders, or to the capital accounts of the proprietors. 
The liability accounts are closed as the individual items 
are liquidated; any gain due to a compromise is, of course, 
credited to Surplus or to Capital account. 

When all the assets have been realized and all the lia¬ 
bilities liquidated, the only accounts remaining on the 
books are, the Cash account, the Capital Stock account, 
and the Surplus account, if the concern is a corporation, 
or the Cash account and the capital accounts of the pro¬ 
prietors, if the concern is a sole proprietorship or a co¬ 
partnership. 

In the case of copartnerships, the accounts of the 
partners are debited with the cash distributed to them 
individually. This closes the books. 

In the case of corporations, the Capital Stock account 
is debited with the par of the shares returned by the 
stockholders for cancellation, and the Surplus account is 
debited with the amount which the stockholders receive, 
in the ratio of the shares which they hold. 

474 


REALIZATION AND LIQUIDATION 


475 


It goes without saying that if the surplus is converted 
into an impairment of the stock, the amount of the im¬ 
pairment being debited to the Capital Stock account re¬ 
duces the latter to the exact amount of cash available 
for distribution. 

It is from the above simple closing process that the 
‘‘Statement of Realization and Liquidation” has been 
evolved. It is not a practical statement, in the sense that 
it is probably never used; but as a theoretical statement 
it has the great advantage of testing the analytic and syn¬ 
thetic powers of the student. It is probably for that 
reason that the New York Board of C.P.A. Examiners 
has given the statement of realization and liquidation such 
prominence in their examinations. 

Statement of Realization and Liquidation 

The mechanism of this statement is logic pure and 
simple. It must show: 

1. The individual assets to be realized 

2. The individual liabilities to be liquidated 

3. The amount realized on the assets 

4. The amount paid to liquidate the debts 

5. The expenses incident to the realization and liqui¬ 

dation 

6. The assets not realized 

7. The liabilities not liquidated 

8. The gains on realization 

9. The losses on realization 

To show all these factors in a single account and bring 
them to a balance, requires less ingenuity than belief in 
the truth of accounting principles and ability to handle 
delicate accounting mechanisms. In fact, the Realization 
and Liquidation account is practically a copy of the trans¬ 
actions incident to the liquidation, so arranged as to make 
it possible for a reader not wholly deficient in accounting 


FINANCIAL STATEMENTS 


476 

knowledge, to perceive at a glance the nature of the 
closing operations. If the statement is adequately pre¬ 
pared, one must be able to single out any asset, ascertain 
its original amount, its increase during liquidation, the 
proceeds of its sale, and the gain or the loss made on its 
realization. One must, besides, be in a position to obtain 
an accurate idea of the aggregate of gains, losses, ex¬ 
penses, and settlements which were made before the affairs 
of the concern were effectively liquidated. 

Preparation of Realization and Liquidation Account 

The following problem and its solution will serve as 
an illustration of the method of preparing the Realization 
and Liquidation account and the principles involved: 


Problem 


The Concrete and Blue Stone Construction Company 
finds itself in the position of having to liquidate, owing to 
its inability to obtain extension of credit and to borrow 
money. Its books show at January 30, 1914: 


Cash. $2,000.00 

Land and Buildings.30,000.00 

Plant Equipment. 22,600.00 

Materials and Supplies 

Inventory. 8,100.00 

Contracts in Process.... 32,000.00 

Finished Contracts. 7,000.00 

Accounts Receivable.... 5,400.00 
Bonds of Other Com¬ 
panies . 11,300.00 

General and Administra¬ 
tion Expense. 9,340-50 

Profit and Loss. 1,600.00 


$129,340.50 


1st Mortgage, Land and 
Building, Interest and 


Principal .$17,230.00 

Notes Payable. 12,300.00 

Sundry Creditors. 52,340.50 

Salaries Due. 2,350.00 

Taxes Due. 120.00 

Capital Stock Outstand¬ 
ing .45,000.00 


$129,340.50 


The account “Finished Contracts” contains charges 
representing allowances to customers for unsatisfactory 























REALIZATION AND LIQUIDATION 


477 


contracts; as an asset, it is worthless. The accounts re¬ 
ceivable represent charges made by the company against 
customers for what the company calls extra work not 
included in specifications; of the whole amount $3,200 is 
disclaimed by customers, and will probably be lost. The 
bonds of other companies were received in settlement of 
contracts, and are worth about $5,000. They are pledged 
to secure $6,000 of notes payable. The account “Con¬ 
tracts in Process” represents cost to date; the amount 
to be received by the company when the contracts are 
completed is $45,000; but it is estimated that it will re¬ 
quire $15,000 to complete said contracts. The sureties 
on the contracts will provide the amount required; they 
purchase, for $6,350, the materials and supplies held by 
the company, and apply them toward the completion of 
the contracts. 

The Cash account shows, at March 30, 1914: 


Initial Balance. 

$2,000.00 

Paid on Mortgage: 


Sale of Land and Build- 


Principal. 


• 

2o.mo.0o 

Interest . 


ms- 3 . ~ 

Sale of Plant Equipment 15,165.40 

Paid for Salaries and 

Sale of Materials and 


Wages. 

.. 2,350.00 

Supplies. 

6,911.10 

Paid for Taxes. 


Collection of Accounts 


Paid to Creditors.... 

.. 52,340.50 

Receivable. 

2,741.20 

Paid at Maturity 

of 

Received on Contracts 


Notes . 


Finished by Sureties. 

31,140.00 

Paid for Expenses 

of 

Interest Credited on 


Liquidation. 

.. 2,938.10 

Bank Balances. 

71.25 

Balance Paid to Stock- 

Sale of Bonds. 

9,100.00 

holders . 


$96,278.95 


$96,278.95 


Required: 

The Realization and Liquidation account, showing 
clearly what took place. 























Realization and Liquidation Account 


478 


FINANCIAL STATEMENTS 


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Total Liquidation of Liabilities.$129,360.80 Total Realization.$111,471.25 

Total .$240,832.05 Total.$240,832.05 
































































FINANCIAL STATEMENTS 


480 

Principles Involved 

The foregoing statement may properly be called a 
synthesis of the results of an analysis. It presupposes that 
the account “Realization and Liquidation” is raised on 
the books, and debited with: 

1. The assets, the individual accounts with which are 

closed 

2. The new assets representing additional income 

during liquidation 

3. The increase of assets due to gains in realization 
and credited with: 

1. The liabilities, the individual accounts with which 

are closed 

2. The new liabilities representing additional income 

charges during liquidation 

While this supposition is not true in practice, it is 
perfectly plausible in theory, and results in gathering into 
a group account, all the assets to be realized and all the 
liabilities to be liquidated. At this point, the accounting 
begins: It must show on the credit side of the account, 
the exact amount of assets which the first section enumer¬ 
ates in detail on the debit side, care being taken to differ¬ 
entiate between proceeds and losses; it must show on the 
debit side of the account, the exact amount of liabilities 
which the first section enumerates in detail on the credit 
side. The only difficulty to be overcome, is that which is 
presented by the treatment of losses and expenses. 

The losses have been accounted for on the credit side 
of the account. This is as it should be, since in practice, 
they would be credited to the individual assets and debited 
to surplus. But also in practice, debits to surplus repre¬ 
sent losses of capital, at least at winding up, and it is 
therefore evident that the effect of such losses must be 
recorded in the realization account. Consequently, they 


REALIZATION AND LIQUIDATION 


481 

are to be shown as deductions from the liability of the 
concern to the stockholders. The same is true of expenses 
incident to liquidation. Thus, when all losses and ex¬ 
penses have been charged to capital stock, there must 
remain in the cash account a balance equal to the balance 
of the stock liability. 

Peter Post Problem 

The Realization and Liquidation account is simple 
enough when established in connection with concerns at¬ 
tending to the liquidation of their own affairs. In recent 
years, the account has been made by boards of C.P.A. 
examiners to apply to the expression of the results of 
the administration of receivers appointed to rehabilitate 
concerns financially embarrassed. When carried to such 
heights, the account is extremely difficult to establish, 
since it brings about accounting for the multiple muta¬ 
tions of assets due to operations. Witness the following 
problem given at the New York C. P. A. examination of 
October, 1907: 

Problem 

The affairs of Peter Post, a manufacturer, were in a 
very critical condition, for, although he had an unimpaired 
investment of $62,500, and his books showed a clear in¬ 
crease of $6,022, he owed his trade creditors $25,289 and 
had only $265 in cash and $4,062 in receivable book 
accounts on which to rely for funds. The rest of his bush 
ness estate was tied up in the following chattels which he 
had acquired in an effort to keep pace with a business 
growth that had outrun his capital: machinery and tools, 
$31,497; raw materials, $18,838; partly made goods, 
$31,562, and finished wares, $7,587. It was also neces¬ 
sary, in order to continue operations, to have immediate 
cash for pay-rolls and incidental expenses. 


482 


FINANCIAL STATEMENTS 


A meeting of his principal creditors was called, and, 
as it appeared that the business was well established, 
profitable, and had a sure and growing market, they de¬ 
cided to advance him $6,000 in cash for immediate needs 
and extend his credit in a sufficient amount to permit of 
the purchase of necessary materials and generally to con¬ 
tinue operations till the present stock of materials could 
be made up and realized on. 

In order to insure the proper application of the funds 
and credit so provided, a trustee was appointed to ad¬ 
minister the finances till the creditors’ claims were 
satisfied, at which time the control would revert to the 
proprietor. 

The subsequent operations under the trusteeship were 
as follows: cash paid for labor, $15,725; for expenses, 
$5,430; for additional tools, $750; purchases on book ac¬ 
count, charged to materials, $6,300; to expenses, $15,000; 
sales on book account, $72,300; loss on collection of book 
debts, $380; personal drawings of Peter Post, $3,500. 

The unliquidated values at the close of the trusteeship 
were as follows: inventory of raw materials, $5,000; 
finished wares, $27,900; accounts receivable outstanding, 
$3,382; and accounts payable, $89. 

Prepare, with due regard to the grouping, order, and 
arrangement of the items, as best calculated clearly to 
display the facts, (a) realization and liquidation account, 
(b) trustee’s cash account, (c) balance sheet of business as 
restored to Peter Post. 


REALIZATION AND LIQUIDATION 

Solution 


483 


Statement of the Results of the Administration of 

Peter Post 

by.... Trustee, from.to. ... 

Section I—Debit Side 


Assets Taken from Peter Post: 

Cash. $265.00 

Accounts Receivable. 4,062.00 

Machinery and Tools. 31,497.00 

Raw Materials. 18,838.00 

Goods in Process. 31,562.00 

Finished Goods. 7,587.00 $93,811.00 


New Assets Obtained During Trusteeship: 

Cash—Loan by Creditors. $6,000.00 

Tools—Purchased for Cash. 750.00 

Raw Materials—Purchased on Credit. 6,300.00 

Sundry Supplies—Purchased on Credit. 15,000.00 

Manufacturing Labor—Paid in Cash. 15,725.00 

Finished Goods—Completed by Trustee. 82,425.00 

Accounts Receivable—Sales by Trustee. 72,300.00 198,500.00 


Total Assets Taken Over and Acquired. $292,311.00 


Operating Gains Made by Trustee: 

Excess of Proceeds of Trading Assets Over Cost 
Thereof: 

Proceeds (Sales). $72,300.00 

Less Cost of Goods Sold: 

Cost of Goods Completed (see 

contra) . $82,425.00 

Less Increase of Inventory of 
Finished Goods. 20,313.00 


Cost of Goods Sold. 62,112.00 10,188.00 


$302,499.00 


Total with which Trustee is chargeable 
































484 


FINANCIAL STATEMENTS 


Statement of Results —Continued 

Section II—Debit Side 

v 

1 

Disposal of Liabilities: 

1. Liabilities Liquidated: 

Trade Creditors. 

2. Liabilities Returned to Peter Post: 

Trade Creditors. 

Total. 

Total Section II. 

Total Sections I and II, Debit Side. 


Section 1—Credit Side 

Liabilities Taken Over: 

Due to Trade Creditors. 

New Liabilities Incurred During Trusteeship: 


Accounts Payable: 

Trade Creditors: 

For Cash Loan. $6,000.00 

“ Raw Materials. 6,300.00 

“ Sundry Supplies. 15,000.00 


Total to be credited to Trustee 


Section II—Credit Side 


Disposal of Assets: 

1. Transformed by Manufacturing Process: 


Goods in Process, Initial Inventory.$31,562.00 

Raw Materials. 20,138.00 

Sundry Manufacturing Supplies. 15,000.00 

Factory Labor. 15,725.00 


Total . 

2. Sold by Trustee (Finished Goods, Sale Price) 


$52,500.00 

89.00 

$52,589.00 

$52,589.00 

$355,088.00 


$25,289.00 


27,300.00 

$52,589.00 


$82,425.00 
72,30a 00 




























REALIZATION AND LIQUIDATION 
Statement of Results— Continued 


485 


3. Expended by Trustee: 

To Liquidate Liabilities. $52,500.00 

“ Purchase Tools. 750.00 

Pay for Manufacturing Labor. 15,725.00 

Pay for Expenses. 5,430.00 

For Advances to Proprietor, Peter Post. 3,500.00 

Total . $77,905.00 

4. Lost in Collection: 

Accounts Receivable. 380.00 

5. Returned to Peter Post, Proprietor: 

Cash. $960.00 

Accounts Receivable. 3,382.00 

Machinery and Tools. 32,247.00 

Goods in Process (None) 

Finished Goods. 27,900.00 

Raw Materials. 5,000.00 


Total.‘. 69,489.00 

Total Section II.$302,499.00 

Total Sections I and II, Credit Side. $355,088.00 


It will be noticed that the above solution presents, in 
one single account, all the requirements of the problem, 
i.e., the trustee’s administration of the affairs of Peter 
Post, the trustee’s cash account, and the balance sheet 
of the business as restored to Peter Post, the latter ex¬ 
cluding the capital account of the proprietor, which can 
readily be ascertained by deducting $89 from $69,489, i.e., 
$69,400. As the proprietor’s capital was originally 
$68,522, as indicated by Section 1 of the account of the 
trustee’s administration, it becomes evident that the in¬ 
crease of Peter Post’s equity in his assets, i.e., $878, has 
been obtained by the trustee as follows: 























486 


FINANCIAL STATEMENTS 


Credit: 

Operating Gain.. • • • $10,188.00 

Debits: 

Losses of Capital. $380.00 

Expenses of Administration. 5,430.00 5,810.00 

Net Gain. $ 4 > 378 °° 

Advanced to Proprietor. 3,500.00 


Increase of Capital during Trusteeship. $878.00 


As to the principles underlying the account, they are 
better understood when the entries recorded in the ac¬ 
count with the trustee are worked in conjunction with 
the account of the proprietor. 

What the proprietor transfers to the trustee, is nothing 
more than his equity in his assets, represented by the 
assets less the liabilities to outsiders. Subsequently, all 
the new assets which are obtained by the trustee, and all 
the increases of assets must, of necessity, be reflected in 
the proprietor’s account, and, as a consequence, in the 
trustee’s account. Similarly, all decreases of assets and 
all increases of liabilities must be reflected in the two 
accounts. In other words, by a series of debits and credits, 
the two accounts exhibit, step by step, the result of the 
transactions which took place, (1) at the time of the 
transfer of assets by the proprietor, (2) pending the 
trustee’s administration, (3) at the time of the discharge 
of the trustee. Thus, the proprietor’s account, which 
might in all propriety appear on the books of the trustee 
if the latter kept separate books, would show: 













REALIZATION AND LIQUIDATION 


487 


Proprietor's Account 
Books of the Trustee 


Liabilities taken over by 


the Trustee.$25,289.00 

Proprietor’s Equity.68,522.00 


$93,811.00 


New Liabilities incurred 

by Trustee.$27,300.00 

Losses made by Trustee. 380.00 
Expenses of the Trus¬ 
tee . 5,430.00 

Advances by Trustee- 3,500.00 

Assets consumed by 

Trustee. 82,425.00 

Assets sold by Trustee.. 72,300.00 
Assets expended by 

Trustee.68,975.00 

Assets returned by Trus¬ 
tee .69,489.00 


$ 329,79900 


Assets taken over by the 
Trustee.$93,811.00 


$93,811.00 


Proprietor’s Equity.$68,522.00 

New Assets acquired by 

Trustee.198,500.00 

Gains made by Trustee.. 10,188.00 
Liabilities liquidated by 

Trustee. 52,500.00 

Liabilities returned by 
the Trustee. 89.00 


$ 329,79900 


It is true, of course, that in practice the proprietor's 
account, if kept, would only contain the following entries: 


Debits 

Liabilities taken over.. .$25,289.00 
Proprietor’s Equity. 68,522.00 


$93,811.00 


Losses. $380.00 

Expenses. 5 , 43 °.oo 

Advances. 3,500.00 

Assets returned. 69,489.00 


$78,799-00 


Credits 


Assets taken over.- 



$93,811.00 

Proprietor’s Equity.., 


Gains. 


Liabilities returned... 



$78,79900 



















































488 


FINANCIAL STATEMENTS 


But we rnqst not forget that, according to accounting 
principles, crediting the proprietor with gain is equivalent 
to crediting him with the assets which he has received 
and debiting him with the assets with which he has parted 
to obtain that gain; that the same is true of losses; that 
debiting the proprietor with expenses is equivalent to 
debiting him with the assets with which he has parted, 
instead of with the cost of the benefits which he has re¬ 
ceived through the incurrence of such expense. 

Returning to the solution of the above problem, the 
reader may perhaps ask why the factory labor expended 
for the manufacture of goods is to be charged to the 
trustee, as representing an asset. If, however, he will bear 
in mind that all the items contributing to cost of goods 
manufactured for sale are assets until the goods are sold, 
and can in nowise be treated as expense, he will answer his 
own question. 

The following solution of the Peter Post problem was 
submitted to the author by a practising accountant as 
fulfilling its requirements. The solution illustrates the 
twist which may be given to the theory of accounts. 


Peter Post 

Statement of Realization and Liquidation 


Assets to be Realized 

Per Balance Sheet: 

Machinery and Tools.. .$31,497.00 

Goods in Process. 31,562.00 

Materials. 18,838.00 

Finished Goods. 7,587.00 

Accounts Receivable.... 4,062.00 

New Assets: 

Accounts Receivable_72,300.00 

Tools. 750.00 


Liabilities to be Liquidated 

Per Balance Sheet: 

Accounts Payable.$25,289.00 


New Liabilities: 
Accounts Payable. 


27,300.00 











REALIZATION AND LIQUIDATION 


489 


Statement of Realization and Liquidation —Continued 


Liabilities Not Li qui- 


dated: 

Accounts Payable. 89.00 

Liabilities Liquidated: 

Accounts Payable.52,500.00 


Supplementary Charges: 

Materials . 25,138.00 

Labor . 15,725.00 

Expense. 20,430.00 

Goods in Process. 31,562.00 

Finished Goods. 7,587.00 

Losses on Accounts Re¬ 
ceivable . 380.00 

Peter Post drawings.... 3,500.00 

Profit on Realization and 
Liquidation. 878.00 


$324,385.00 


Assets Not Realized: 

Machinery and Tools... 32,247.00 
Accounts Receivable.... 3,382.00 


Assets Realized: 

Materials. 18,838.00 

Goods in Process.31,562.00 

Finished Goods. 7,587.00 


Accounts Receivable.... 72,600.00 


Losses on Realization: 

Accounts Receivable.... 380.00 

Supplementary Credits: 

Sales. 72,300.00 

Inventory—Materials ... 5,000.00 

Inventory — Finished 
Goods .27,900.00 


$324,385.00 


Trustee’s Cash Account 


Balance. $265.00 

Creditors (Loan). 6,000.00 


Accounts Receivable.... 72,600.00 


$78,865.00 


Labor .$15,725.00 

Expenses . 5,43°.oo 

Tools . 750.00 

Accounts Payable.52,500.00 

Drawings Peter Post... 3,500.00 

Balance. 960.00 


$78,865.00 


$960.00 


Balance 










































490 


FINANCIAL STATEMENTS 


Balance Sheet 


Assets 

Machinery and Tools.. .$32,247.00 
Materials and Supplies.. 5,000.00 


Finished Goods.27,900.00 

Cash . 960.00 


Accounts Receivable.... 3,382.00 


$69,489.00 


Liabilities and Capital 


Accounts Payable. $89.00 

Capital .62,500.00 

Surplus: 

Prior to ap¬ 
pointment of 


Trustee_$6,022.00 

Profit and Loss 
o f Realiza- 
t i o n and 
Liquidation. 4,378.00 


$10,400.00 

Drawings.... 3,500.00 6,900.00 


$69,489.00 


It will be noticed that the foregoing solution charges 
the trustee, under what is called “Supplementary 
Charges,” with: 

Losses of Accounts Receivable.. . .$ 380.00 

Expense of Realization. 20,430.00 


or a total of.$20,810.00 

with which he cannot be charged under any rules of ac¬ 
counting, and that it carries inconsistency to the extent 
of debiting the trustee with profit on realization. No 
matter how lightly one may treat accounting principles, 
a trustee cannot be charged, at the same time, with profits 
and losses. As to charging the trustee with the drawings 
of the proprietor, it is outside of the limits of possibilities. 

Nothing but strict adherence to principles will satisfy 
accounting requirements. 



















CHAPTER XLI 


THE ACCOUNTS OF FIDUCIARIES 
Academic Theories 

In the course of accounting instruction as offered to¬ 
day, some prominence is given to so-called “Accounts of 
Executors.” When reduced to its accounting expression, 
such a course consists of little more than a differentiation 
between principal and income, general data about the 
duties of executors to the estate, and laboratory work 
upon the schedules to be presented by the fiduciary in final 
accounting. 

In differentiating between principal and income, the 
chief principles of the law are given as the standard by 
which the accounting facts will be judged. This, of course, 
is as it should be; but unfortunately, the courts have not 
always been willing to accept the views of accountants 
upon matters relating to the interests of the life-tenant 
as opposed to the interests of the remainderman. 

In treating of the accounts of the testamentary 
trustee, a complete set of books is usually evolved, and 
the student is carefully taught to debit cash and to credit 
the estate; to credit cash and to debit the estate, etc., etc. 
Special forms are submitted, which are said to have re¬ 
sulted from the best thought of men who have spent their 
lives in the treatment of the accounts of fiduciaries. 

Statutory Provisions 

Coming down to facts, we find that American statutes 
prescribe no uniform accounting for executors; that these 

491 


492 


FINANCIAL STATEMENTS 


trustees may keep their books precisely as they will, pro¬ 
vided they are able to account properly to the court for 
their administration of the estate. What the law does 
attempt to regulate, is the interpretation to be given to 
the word “assets,” that is to say, what shall be included 
in the inventory to be filed by the executor and be subse¬ 
quently accounted for by him. 

Section 2714 of the New York Code of Civil Proce¬ 
dure, given below, provides that the assets to be inven¬ 
toried are the personal assets of the deceased. 

“The inventory must contain a particular statement of 
all bonds, mortgages, notes, and other securities for the 
payment of money belonging to the deceased, known to 
the executor or administrator; with the name of the 
debtor in each security, the date, the sum originally pay¬ 
able; the indorsements thereon, if any, with their dates 
and the sum which, in the judgment of the appraisers, is 
collectable on each security; and of all moneys, whether 
in specie or bank bills, or other circulating medium, be¬ 
longing to the deceased, which have come to the hands 
of the executor or administrator, and if none have come 
into his hands, the fact shall be stated in the inventory. 

“The naming of a person executor in a will does not 
operate as a discharge or bequest of any just claim which 
the testator had against him; but it must be included 
among the credits and effects of the deceased in the in¬ 
ventory, and the executor shall be liable for the same as 
for so much money in his hands at the time the debt or 
demand becomes due, and he must apply and distribute 
the same in the payment of debts and legacies, and arnong 
the next of kin as part of the personal property of the de¬ 
ceased. The discharge or bequest in a will of a debt or 
demand of the testator against an executor named therein, 
or against any other person, is not valid as against the 
creditors of the deceased; but must be construed only as 


THE ACCOUNTS OF FIDUCIARIES 


493 


a specific bequest of such debt or demand; and the amount 
thereof must be included in the inventory and, if necessary, 
be applied in the payment of his debts; and if not necessary 
for that purpose, must be paid in the same manner and 
proportion as other specific legacies. 

“If personal property not mentioned in any inventory 
come to the possession or knowledge of an executor or 
administrator, he must cause the same to be appraised as 
herein required, and an inventory thereof to be returned 
within two months after the discovery thereof; and the 
making of such inventory and return may be enforced in 
the same manner as in the case of a first inventory.’" 

Executor’s Accounting 

It is around the inventory, as filed, that the accounting 
of the executor to the courts revolves. He must charge 
himself with the increases of that inventory, and such in¬ 
creases automatically become part of the total to be 
accounted for. It is not with the net of the increases, after 
the deduction of losses from gains, that the executor must 
charge himself, but with the gross amount. As to the 
decreases, he must explain them in full in a separate part 
of his account. 

As will be noticed, the section of the law quoted above, 
refers only to personal property. As a matter of principle, 
the executor has no right whatever to the possession of 
real estate, unless it be specifically devised to him in trust. 
If, however, it is necessary for the executor to collect 
rentals, or to sell the real estate in order to pay the debts 
of the testator, the executor of the estate may derive from 
the statutes, or from the will itself, sufficient authority 
to proceed. 

The accounting by the executor is essentially a matter 
of schedules, which will be given in the course of the 
present chapter; but his administration of the estate is 


494 


FINANCIAL STATEMENTS 


subjected by law to certain rules which he must apply for 
the protection of all parties at interest, including himself. 
He must support, by proper vouchers, all disbursements 
which he makes over and above an amount of $20; and 
the sum of small payments not supported by proper 
vouchers must not exceed $500. If, however, a voucher 
for any sum disbursed has been lost or accidentally de¬ 
stroyed, the sworn statement of the payee, coupled with 
the justification for the expenditure, will discharge the 
executor. As evidenced by the order of the schedules 
which he must submit, the classes of disbursements which 
the executor is empowered to make are as follows: 

1. Funeral and administration expenses 

2. The payment of debts owed by the deceased 

3. The payments to legatees, widow, or next of kin 

for their share of the estate as per the will 

Payment of Debts and Legacies 

As to the payment of the debts of the deceased, the 
debts preferred by statute must be paid first, and with 
proper diligence. Generally speaking, these debts are: 

1. Duties to the Federal Government on imported 

goods, etc. 

2. Taxes assessed upon the property of the decedent 

3. Docketed judgments 

The order in which these classes of debts are to be 
paid is precisely that given above; the executor must pay 
one class entirely before he may proceed to the others; 
he must first pay the debts due, but he may simulta¬ 
neously pay debts not as yet matured, provided he deducts 
therefrom interest to the maturity of the debt. 

As to all the other debts, they constitute a fourth class 
and are paid according to their maturity. It must be 
stated, however, that a real estate mortgage cannot be 
paid out of the personal estate unless the will has so pro- 


THE ACCOUNTS OF FIDUCIARIES 


495 


vided; and it must also be borne in mind that che executor 
has no right to pay or to revive a debt which has been 
barred by the statute of limitations. 

Concerning legacies, the executor must not pay them 
before the expiration of one year, unless the will provides 
otherwise. But even in this case the legacy is paid subject 
to a bonded liability of the legatee contingent upon the 
sufficiency of the remainder of the estate to pay the debts 
of the testator. 

The Executor’s Compensation 

In the State of New York the law provides for the 
compensation of testamentary trustees in all cases where 
the will has not specially provided therefor, or where the 
executor has legally renounced the compensation assigned 
to him by the will. The amount of such legal compensa¬ 
tion, or, as it is more frequently termed, “commissions,” is, 
generally speaking, computed on the amounts received and 
paid out. The rate is : 

On a sum not exceeding $1,000. 5% 

On a second sum not exceeding $10,000 
On the remainder, above $11,000. 1% 

While it is a recognized principle that where more 
than one executor is named, each executor receives com¬ 
missions according to the services which he renders, there 
is a provision made by the New York law for the com¬ 
pensation of each executor of an estate valued at $100,000 
or more in personal property over and above all debts. 
In such cases each executor is entitled to the full commis¬ 
sion allowed when only one executor administers the 
estate. If, however, there are more than three executors, 
the compensation to which three would be entitled alto¬ 
gether, must be divided among all according to the value 
of the services rendered by them individually. 




49 6 FINANCIAL STATEMENTS 

Form of Executor’s Account 

The following form of the account of an executor is 
in vogue in the Court of the Surrogate of the County of 
New York: 

Surrogate’s Court, 

County of New York. 

i ■■ ■ ■ . ■ .I.i 

In the matter of the judicial settlement 
of the account of M. T. Fordham, 

> 

of New York, 

deceased 


To the Surrogate of the County of New York: 

I, A. Abner, of the City of New York, in the County of New York, 
do hereby render the following account of the proceedings as the 
executor of the estate of the said deceased. 

On the .... day of ...., A. D., 191. ., I caused an inventory of the 
personal estate of the said deceased to be filed i" * 1 the office of the 
Surrogate of the County of New York, which personal estate therein 
set forth amounts, by appraisement by the appraisers duly appointed, to 
$13,610.20. 

Schedule A, hereto annexed, contains a statement of all the prop¬ 
erty contained in said inventory, sold by me at public or private sale, 
with the prices and manner of sale; which sales were fairly made by 
me at the best prices that could then be had with due diligence, as I 
then believed; it also contains a statement of all the debts due the 
said estate and mentioned in said inventory, which have been collected, 
and also of all interest or moneys received by me for which I am 
legally accountable. 

Schedule B, hereto annexed, contains a statement of all debts in 
said inventory mentioned, not collected or collectable by me, together 
with the reasons why the same have not been collected and are not 
collectable; and also a statement of the articles of personal property 
mentioned in said inventory, now unsold, and the reasons of the same 
being unsold, and their appraised value; and also a statement of all 
property mentioned therein, lost by accident, without any wilful default 
or negligence, the cause of its loss and its appraised value. No other 
assets than those in said inventory, or herein set forth, have come to 
my possession or knowledge, and all the increase or decrease in the 
value of any assets of said deceased is allowed or charged in said 
Schedules A and B. 

Schedule C, hereto annexed, contains a statement of all moneys 
paid by me for funeral and other necessary expenses for said estate, 
together with the reasons and object of such expenditure. 





THE ACCOUNTS OF FIDUCIARIES 


497 


On or about the .... day of. in the year 191.., I caused 

a notice for claimants to present their claims against the said estate to 
me within the period fixed by law, and at a certain place therein 
specified, to be published in two newspapers, according to law, for six 
months, pursuant to an order of the Surrogate of the County of New 
York, to which order, notice, and due proof of publication herewith 
filed, I refer as part of this account. 

Schedule D, hereto annexed, contains a statement of all the claims 
of creditors presented to and allowed by me or disputed by me and for 
which a judgment or decree has been rendered against me, together 
with the names of the claimants, the general nature of the claim, its 
amount, and the time of the rendition of the judgment; it also contains 
a statement of all moneys paid by me to the creditors of the deceased, 
and their names, and the time of such payment. 

Schedule E, hereto annexed, contains a statement of all moneys paid 
to the legatees, widow, or next of kin of the deceased. 

Schedule F, hereto annexed, contains the names of all persons 
entitled as widow, legatee, or next of kin of the deceased, to a share 
of his estate, with their places of residence, degree of relationship, and 
a statement of which of them are minors, and whether they have any 
general guardian, and, if so, their names and places of residence, to the 
best of my knowledge, information, and belief. 

Schedule G, hereto annexed, contains a statement of all other facts 
affecting the administration of said estate, his rights, and those of 
others interested therein. 


I charge myself as follows: 

With amount of inventory. $ 

increase, as shown by Exhibit A... . 

Total.$ 


I credit myself as follows: 

With amount of loss on sales, as per Schedule B.... $. 

“ debts not collected, as per Schedule B. 

“ Schedule C. 

“ Schedule D. 

“ Schedule E. 


Total. $ 

Leaving a balance of.$ 


to be distributed to those entitled thereto, subject to the deductions of 
the amount of commissions, and the expenses of this accounting. The 
said schedules, which are signed by me, form part of this account. 




















498 


FINANCIAL STATEMENTS 


Schedule A 
Sales of 

Cash—From Whom Property .. , _ , 

Received and All and Debts Rents Interest Dividends Total 

Necessary Information Due 

Deceased 

U. S. Mortgage and Trust 
Co.—Cash on Deposit.. 

Dime Savings Bank—Cash 

on Deposit. 

N. Y. Life Insurance Co.— 

Policy No.. payable 

to estate. 

Browner & Simplex—Sal¬ 
ary due testator. 

J. Spruce—Promissory note 

due this day. 

S. Turner—Mortgage Bond, 

Principal and Interest... 

Unknown — 50 shares of 
Bacillac Co., Dividend de¬ 
clared thereon—on. 

Unknown—Personal wear¬ 
ing apparel. 

(Signed) A. Abner, 

Executor of the Estate of 

M. T. Fordham, deceased. 

Schedule B (4 Parts) Part 1 

Property Mentioned in Inventory, Lost by Accident Without Any Wilful 
Default or Negligence; the Cause of Its Loss and Appraised Value 

(None) 

Schedule B Part 2 

Decrease of the Value of Any Assets of Deceased Mentioned in 

Inventory 

(None) 

Schedule B Part 3 

Debts Mentioned in Inventory Not Collected or Collectable, With 
Reasons Why They Have Not Been Collected and Are Not 
Collectable, and Their Appraised Value 
(None) 

Schedule B Part 4 

Personal Property Mentioned in Inventory Unsold; and the Reasons of 

the Same Being Unsold, and Its Appraised Value 

(None) 








499 


THE ACCOUNTS OF FIDUCIARIES 

r 

Schedule C, D, and E 


Names Schedule C Schedule D Schedule E 


Cash—To Whom Paid, with Debts 

Reasons and Object of Expenses Owed 
Expenditure by the 

• Deceased 

Unknown—Funeral Expenses 
—Legal Expenses... 

Sundry—Executor’s Expenses 
Unknown — Rent of Apart¬ 
ment . 

T. B. Roe, M.D., Profes¬ 
sional services to testator.. 

Universal Pharmacy — Drugs 

for testator. 

Miss Spence — Professional 

services to testator. 

Anna Fordham — Sister of 

deceased . 

Mary Fordham — Mother of 
deceased . 


Paid to 
Legatees, 
Widow, or 
Next of 
Kin of 
Deceased 


Total 


(Signed) A. Abner, 

Executor of the Estate of 

M. T. Fordham, deceased. 


Schedule F (2 Parts) 


Part 1 


Persons Entitled as Widow, Legatee, 
or Next of Kin to the Deceased to a Residence 
Share of the Estate 

Anna Fordham. 

Mary Fordham. 

George Tesley. 

Ruth Tesley. 


Degree of 
Relationship 

Testator’s Sister 
Testator’s Mother 
Testator’s Nephew 
Testator’s Niece 


(Signed) A. Abner, 

Executor of the Estate of 

M. T. Fordham, deceased. 


Schedule F Part 2 

Names of Minors Name of Guardian Residence of Guardian 

(None) 











5°° 


FINANCIAL STATEMENTS 


Schedule G 

Statement of All Other Facts Affecting the Estate Not Included in Any 

Other Schedule 

Commissions Claimed by A. Abner, Executor: 


5 % on ist. $1,000.00 

2 ]/ 2 % on next . 10,000.00 


1 % on balance 

(Signed) A. Abner, 

Executor of the Estate of 

M. T. Fordham, deceased. 


Contents of Schedules 

It will be noticed that Schedule A contains: 

In the first column: 

The proceeds of the sale of the corpus of the estate; 
hence, the column contains the corpus as repre¬ 
sented by the inventory filed, the increases of such 
inventory through sales, and also the decreases 
thereof through sales. 

In the second column: 

The income derived from the real estate which, either 
under the provisions of the will or through the 
necessities of the estate, has come within the con¬ 
trol of the executor. 

In the third and fourth columns: 

The other income earned by the estate. 

This means that, in order to charge the executor with 
the increase of the inventory, it is necessary to refer to 
the said inventory, and, by comparison, to single out the 
particular items the proceeds of which have been greater 
than their appraised value. 

As to the losses on sale, represented by the excess of 
the appraisal over the proceeds, they are stated in Sched¬ 
ule B, which is all the more interesting because it shows: 




THE ACCOUNTS OF FIDUCIARIES 


501 

1. That the class of losses referred to in the summary 

as “Losses on Sales” is actually composed of 

two classes of losses: 

a. Losses due to accidents or to causes over 

which the care and prudence of the executor 
have no control 

b. Losses due to insufficiency of proceeds when 

compared with the appraisal made at in¬ 
ventory time 

2. That the class of items referred to in the summary 

as “Debts Not Collected,” is actually composed 

of two classes of facts: 

a. Debts not collected, or not collectable 

b. Inventory items not sold 

Differentiation Between Principal and Income 

The question of differentiation between principal and 
income, as affecting the rights of life-tenants and remain¬ 
dermen, is primarily one of investment accounting. It 
arises only in cases where the funds out of which the in¬ 
come of the life-tenant is to be paid, have been invested 
in securities subsequent to the death of the testator. 

When accountants have presented their interesting 
and highly commendable arguments in favor of the judicial 
interpretation of wills according to scientific principles, 
it remains true that courts will insist upon an interpreta¬ 
tion which is in accordance with the intent of the testator. 
If he intended that the face value of coupons of interest 
be paid to the life-tenant, and such intention is made clear 
by the terms of the will, or by the surrounding circum¬ 
stances and conditions, it would be unfair to deduct from 
the proceeds of these coupons a sum which at compound 
interest would return to the funds of the remainderman 
the premium paid by the executor on the interest-bearing 
bonds. 






































. i. 





























































INDEX 


A 

Accountancy of investment (See 
“Investments”) 

Accountants, duties of, on dissolu- 
tion of partnership, 23 
Accounting 

accrual basis of, 300, 301 
cash basis of, 299 
principles of, as to net assets 
and net income, 300 
Accounting systems 
double entry, 69-79 
logismography, 80-82 
single entry, 54-68 
statmography, 82-83 
Accounting theories 
concerning fiduciaries, 491 
of bond issues, 338, 339 
of depreciation, 439 
preliminary studies, 19 
relation to business law, 19 
Account, proprietor’s 
assets and liabilties in, 63, 64 
debits and credits in, 64-66 
in single-entry ledger, 59, 60 
in single-entry system, 54-68 
with bills payable, 61, 65 
with cash, 60, 61, 66 
with creditors, 60, 62, 65 
with customers, 60, 62, 65 
with merchandise, 62, 64 
Account, realization and liquida¬ 
tion, 475-490 

Peter Post problem, 481-490 
preparation of, 476-490 
principles involved in, 480 
Accounts 
asset, 134-137 


cash (See “Cash Account”) 
classification of, 131, 134 
clearing of mixed, 312-314 
controlling, 124-130 
creditors’, 57, 60, 62, 65 
customers’, 55, 56, 60, 62, 65 
drawing, 381-383 
economic, 132 
fictitious, 132 
liability, 134, 135, 137, 138 
loans payable, 382 
loss and gain, 132 
meaning of ledger, 121, 122 
nominal, 132 

nominal in double entry, 73 
of fiduciaries, 491-501 
partly real, partly nominal, 133, 
308 

payable, 354, 355 
personal and impersonal, 131 
proprietorship, 380-383 
real, 131 

representative, 133 
sundry, 122 
unapplied profits, 382 
undivided profits, 382 
with bond premiums and dis¬ 
counts, 341 , 342, 344 
with bonds, 269, 270 
with discounts on capital stock, 
332 , 333 

with donated stock, 334 
with goods (See “Merchandise 
Account”) 

with partnership before referee, 

23 

with premiums on capital stock, 
332 , 333 


S°3 


504 


INDEX 


Accounts, corporate 
capital stock balance, 48 
subscriptions, 46 
form, 45 

with stock, 48-52 
forms, 50, Si, 53 
Accounts payable 
audited vouchers, 355 
components of, 354 
dividends declared, 355, 356 
in balance sheet, 354 
in general ledger, 354, 355 
profits undistributed, 357 
records of, 354 
Accounts receivable 
in general ledger, 156 
items comprised in, 157 
Accrual basis of accounting, 300, 

301 

Accrued liabilities (See “Liabili¬ 
ties”) 

Additions defined, 228 
Advertising 

apportioning cost of, 310 
left-over material for, 312 
unexpired contracts for, 310, 311 
American Association of Public 
Accountants, definition of as¬ 
sets, 135 
Amortization 

accuracy of methods of, 273, 277 
data required for, 280 
illustrative examples of, 274, 276, 
278, 279, 282 
method of, 281-283 
of bond premiums and dis¬ 
counts, 273, 275 
of part of cost, 272 
views of courts on, 279 
Assessments against real estate, 
286, 287, 364 
Assets 

accounting definition of, 136 
accounts with, 134, 135, 137 
copyrights, 255 


definitions of, 135, 136 
dividends, 301 
good-will, 247 
loans on collateral, 268 
nature of physical, 377 
notes as, 161 

of concerns about to liquidate, 
136 

of going concerns, 136 
of partnership at dissolution, 21 
on accrual basis, 300 
patents, 251 
problem in, 390 
proof of ledger, 389, 392 
trade-marks, 254 
Assets and liabilities 
statement of, in single entry, 67 
Auditor of corporation, 43 

B 

Balance sheet, 396-429, 447-460 
accounts payable in, 354 
arrangement of assets and lia¬ 
bilities, 406-417 
consolidated, 447-460 
developed into ledger, 405 
double form of, 410-412 
English arrangement of, 406 
form for banks, 418-421 
form for life insurance com¬ 
panies, 421-423 

form for steam roads, 424-428 
of assets and liabilities, 394 
order of items in, 407 
problem in finding, 386 
reading of, 416, 417 
usual form of, 408 
variant forms of, 409, 413 
working form of, 396-397 
Balance sheet, consolidated, 447-460 
comment on problem in forma¬ 
tion, 457-460 
elements of, 447 
elimination of items in, 459 


INDEX 


505 


Balance sheet, consolidated— con¬ 
tinued 

formation of, 453-456 
form of, 449-452 
problem in making, 449, 450 
purpose of, 447 
Bank ledger, in 

Bankruptcy Act, on partnerships, 23 
Banks 

balance sheet for, 418-421 
view on capital and surplus, 30 
Betterments defined, 228 
Bills of exchange (See also “Ac¬ 
counts" and “Bills Payable”), 
351 , 352 

definitions of, 163, 164 
relations created, 164 
relation to bills receivable, 163, 
164 

Bills payable 
accounts with, 61, 65 
journal entry for, 351 
memorandum checks, 352 
parties to, 351, 352 
postdated checks, 351 
Bills receivable, 163 
Bonds, 336-345 

accounting theories of isstied, 
338 , 339 

accounts with, 269, 270 
acquired by issuing company, 
339-342 

as investments, 270 

as trust funds, 280 

characteristics of, 34 

collateral trust, 35 

consolidated, 38 

convertible, 38 

coupon, 38 

debenture, 35, 37 

discounts on sales of, 341, 34 2 

divisional, 36, 37 

equipment, 35 

floated by stock issue, 33 

income, 37 


income from, 305 
interest on, 38, 271 
investment accounting with, 273- 
283 

issues of, 337 

kinds and classes of, 34-38, 337 

land grant, 36 

liability for, 339 

mortgage, 36, 37 

partly secured, 37 

premiums on sales of, 341, 342 

real estate, 36 

redeemable, 37 

refunding, 38 

requirements of state law as to, 
34 

secured, 35, 36 
security for loan, 263 
terminal, 36 
unsecured, 37 
Bonus, stock as, 33 
Bookkeeping, definition of, 121 
Book values, adjustment to mar¬ 
ket value, 284 

Boston ledger (See “Ledger”) 
Buildings 

account with, 223-226 
additions defined, 228 
betterments defined, 228 
construction costs, 225 
distinct from land, 221 
expenditures on, 226-228 
increased valuation of, 229 
labor and expenditures on, 225 
original cost of, 224 
renewals defined, 228 
repairs defined, 229 
replacements defined, 229 
By-laws, corporate, 39, 40 

C 

Capital 

distinguished from capital stock, 
29 

in limited partnership, 21 


5°6 


INDEX 


Capital —continued 
of corporations, 29 
of partners, 382 

relation to profits and surplus, 
30 

Capital expenditures (See “Ex¬ 
penditures”) 

Capital stock (See “Stock”) 

Cash 

accounts with, in single entry, 
60, 61, 66, 67 
disbursements, 61 
journal transactions in, 86, 87 
receipts from sales, 60, 61 
treasurer’s memoranda of, 144 
form, 148 
Cash account 
examples of, 140, 141 
forms, 146-148, 150 
in single entry, 66, 67 
petty, 145 

proper operation of, 143-145 
relation to cash balance, 142 
theory of, 139 

with receipts and disbursements, 
139 

Cash basis of accounting, 299 
Cash book (journal) 
debits and credits in, 87 
developed into journal, 96 
forms, 97, 98, 100 
illustrative entries in, 93, 94 
petty, 99 

primitive form of, 93 
Cash discounts, 438 
Cash journal (See “Cash Book”) 
Certificates, stock 
binds stockholders, 31 
issue of, not essential, 31 
Check registers (See “Registers”) 
Checks 

acceptance of, 351 
canceled, 143, 147 
form of register, 147 
memorandum, 352 


postdated, 351 
register of, 143, 144 
Claims, against partnerships, 25 
Collateral 
accounts with, 270 
form, 269 

loans secured by, 268 
Commission 
accounting for, 195, 204 
form, 218 
defined, 186 

“del credere” agreement, 187 
journal entries for, 197, 199, 206 
record of, 192 

Commission merchant (See “Con¬ 
signees”) 

Common stock, 30, 360 
defined, 30 
par value of, 29 

Conditional sales (See “Sales”) 
Consignees 
accounts of, 189-192 
advances made by, 188 
books for separate agency ac¬ 
counts, 200 
books of, 190-192 
classes of, 186 

closing entries on books of, 196, 
197 

commissions, advances and ex¬ 
penses, how determined, 194 
duties and liabilities of, 187-192 
expenses of, 188 
instructions from consignors, 
187-188 

liens of, for expenses, 188 
may accept notes in settlement, 

188 

may not refuse draft on notice, 

189 

not chargeable with interest on 
deferred statement, 189 
occasional, 187 

prerogatives of, in absence of 
instructions, 187 



INDEX 


507 


Consignees —continued 
relations with consignors, 186 
separate agency accounts of, 200 
state requirements as to bonds 
for, 186 

theory of occasional, 203 
trial balance of, 193, 198 
Consignments (See also “Ship¬ 
ments”) 

acceptance of, by factor, 189 
account sales for, 198, 199 
book records of, 191, 192 
criticism of consignment ac¬ 
count theories, 207 
entries on receipt of, 203-205 
entries on sales of, 204-206 
forms. 201, 202, 218 
importance of subject, 186 
journal entries for, 194-196, 204- 
206 

occasional, 203-207 
shipments inward, 186-207 
shipments outward, 208-220 
Consignor 

account sales rendered by con¬ 
signee, 198 

accounts with, on consignee’s 
books, 191, 192 
relations with factor, 190 
Consolidated balance sheet (See 
“Balance Sheet, Consolidated”) 
Consolidation of corporations, 447 
Contingent liability 
entries for, 162, 163 
for promissory notes, 161, 162 
reserves for, 370, 373 
Controlled companies, 448 
Controlling accounts 
explanation of, 125 
from subsidiary ledgers, 129, 
130 

genesis of, 125 
illustration of, 127 
in self-balancing ledger, 129 


journal provision for, 127 
theory of, 126 

Copartnership (See “Partner¬ 
ships”) 

Copyrights 
as an asset, 255, 256 
as personal property, 255 
assignable, 256 
capitalized as good-will, 256 
definition of, 255 
duration of, 255 
how obtained, 255 
salable, 256 

Corporate records (See “Rec¬ 
ords”) 

Corporations 
board of directors, 39 
business, 29 
by-laws of, 39, 40 
capital liability of, 321, 322 
capital of, 29 
classes of, 29 
debts of, 33 
defined, 28 
financial, 29, 135 
in Austria-Hungary, 317 
in Germany, 318 
officers of, 42, 43 
organization and management 
of, 39-43 

organization expenses of, 316- 
318 

power to acquire property, 32 
public service, 29, 36 
records of (See also “Records”), 
44-53 

restrictions on, 20 
stock and non-stock, 28 
stockholders of, 41 

Cost 

book increase of, 440 
interest an element of, 439 
of bonds, defined, 272 
of goods, 438 
of labor, 174, 175 


5°8 


INDEX 


Cost —continued 

of manufacturing concerns, 173- 
176 

of raw materials, 174 
overhead, 175, 182-185 
pre-process, 173 
relation to income, 272 
Cost sheet, 180 
Credits, deferred 
cash receipts, 366, 367 
defined, 366 
discounts, 366 
hospital fund, 368 
Interstate Commerce Commis¬ 
sion on, 367, 368 
items of, 366, 367 
operating reserves, 367, 368 
premiums, 366 
unearned fees, 366, 367 
Customers’ accounts, 154-157 
composition of, 154 
debits and credits in, 154 
deductions in, 154 
discounts in, 155 
policy as to charges, 156 
record of sales in, 154 
refunds in, 154 
returned sales in, 154 

D 

Debentures 

of financial institutions, 35 
of railroads, 37 

Debits and credits, in single entry, 
55-57 

Debits, deferred 
classification of, 316 
list of, 315 
nature of, 315 
regarded as assets, 315 
Debt 

bonded, 336-345 (See also 
“Bonds”) 
defined, 336 
evidence of, 336 


kinds of funded, 336 
mortgage, 346-350 
of corporation, 33 
of decedent, 493 
unsecured, 350-353 
Defeasance, in mortgage contract, 
267 

Deferred debit items (See 
“Debits”) 

Deferred credits (See “Credits”) 
Deficiency account, 471-473 
Del credere agreement, 187 
Depreciation 

of machinery, 241, 242, 295, 372 
provision for, 378-380 
reserves for, 371-373 
Directors, board of 
courts of equity and, 41 
election of, 39, 40 
fiduciary character of, 41 
may declare stock subscriptions 
forfeited, 32 

rights and powers of, 40, 41 
Disbursements 
application of word, 389 
in single entry, 60, 61 
of assets, 389, 393, 395 
of cash, 389 
Discounts 

bond, in interest account, 342, 
343 

cash, 438 

deductions for, 155 
entries for, 155 
journal entries for, 169 
ledger account with, 156 
on bond sales, 341, 342 
relation to merchandise account, 
167 

trade, definition of, 155 
Dividends 

accounting treatment of, 362 
as asset and income, 301 
as corporation debts, 30 
defined, 30 


INDEX 


Dividends —continued 
from invested values, 359-361 
from profits, 359-361 
on mining stock, 284 
stock, 361 

Donation account, 334 
Double-entry system 
a balancing system, 69-71 
distinguished from single entry, 
75 

nature of journal, 75 
nominal accounts in, 73 
origin of, 59 

passing to, from single entry, 
76-79 

principles of, 69, 70 
profit and loss in, 73 
purpose of, 69 
rules for, 74 

rules for journalizing, 71-73 
Drawing accounts, 381-383 

E 

Earnings on investments, 301-305 
records of, 302-305 
Equations in single entry, 58 
Equilibrium 
how established, 129 
in double entry, 71, 74 
in single entry, 68 
Equipment 
book value of, 235 
delivery, 235 
general, 237 

horse, wagon and harness, 235 
replacements and additions to, 
235 

Equity of sole proprietor, 381 
Excise taxes, 365 
Executor 

accounting of, 493, 494 
accounts of, forms and sched¬ 
ules, 496, 501 
compensation of, 495, 496 


509 

Expenditures (See also “Ex¬ 
penses”) 

capital, 226, 227, 444 
Public Service Commission 
on, 228, 229 
revenue, 226, 227 
Expense distribution 
labor and material rate, 183 
labor basis, 182, 183 
machine rate basis, 183, 184 
material rate, 183 
pay rate, 183 
Expenses 

allocation of periodical, 307 
legal, 260 

organization, 316-318 
F 

Factor (See “Consignees”) 

Fees 

defined, 364 
for licenses, 364 
Fiduciaries, accounts of, 491-501 
courses of instruction in, 491 
differentiation of principal and 
income, 491, 501 

executor’s accounts, 493, 494, 
496, 501 

payment of debts and legacies, 
495 

statutory provisions for, 491, 
492 , 495 

the inventory, 492, 493 
Financial statements (See “State¬ 
ments”) 

Fire insurance (See “Insurance”) 
Fixtures 

court decisions on, 233 
law of, 232, 233 
personalty, 231 

realty and personalty distin¬ 
guished, 233, 234 
realty defined, 231 
Forfeiture of stock subscriptions, 
32 


INDEX 


510 

Franchises 

characteristics of, 258 
debits to, 258, 259 
definition of, 256 
of public service corporations, 
259, 260 
primary, 257 
secondary, 257 
state and municipal, 258 
Funded debt (See “Bonds”) 
Funded reserves, 293 
Funds, specific 
kinds of, 292 
purpose of, 292 
reserves, 293-295 
sinking funds, 296-299 
Furniture (See also “Fixtures”) 
definition of, 234 

G 

General ledger, 116, 117, 124 (See 
also “Ledger”) 

Goods 

in finished stage, 175 
in process, 174 
inventories of, 176-182 
forms, 178, 180 
Good-will 

an intangible asset, 244 
as an asset, 247 
component parts, 458 
creation of, 249, 250 
depreciation of, 248, 249 
of controlled company, 457 
of corporations, 245, 246 
of sole proprietorships, 245 
personal character of, 244 
sale of, 247 

treatment of in consolidations, 
246 

value of in partnership, 26 
H 

Holding company 
components of, 448 


problem in incorporating, 449- 
460 

purpose of, 447 

I 

Imprest fund 
book for, 99 
forms, 100 
how maintained, 151 
journal entry for, 152 
origin of, 152 
theory of, 152 
Income 

accrual basis of, 300 
accruals of, 395 
accrued, not due, 299-306 
distributing debits to, 405 
dividends as, 301 
from bonds, 305 
from investments, 299 
in financial statements, 430-438 
on bond investments, 272, 273 
only cash considered, 299 
relation to cost, 272 
Incumbrances 
liability for, 287 
on real estate, 286, 288 
Industrial enterprises, capital ex¬ 
penditures for, 227, 228 
Inheritance tax, 366 
Insurance, fire 
account with, 308 
premiums on, 309, 310 
refund of premiums, 309 
Union short rate tables, 310 
Interest 

accrued on investments, 305 
as affecting cost of investment, 
271 

as an element of cost, 439 
bond premiums and discounts 
as, 342, 343 

entries for accrued, 304, 305 
on bonds purchased for invest¬ 
ment, 270, 271 
on mortgages, 265 


INDEX 


511 


Interstate Commerce Commission 
balance sheet form for steam 
roads, 424-428 

on “Capital Stock Liabilities,” 
329 

on “Deferred Debits,” 315 
on “Organization Expenses,” 317 
on “Reserves,” 293, 295 
ruling as to income and sur¬ 
plus, 444 

ruling on asset terminology, 413 
ruling on balance sheet, 368 
ruling on capital stock deferred 
credits, 367 

ruling on capital stock deferred 
debits, 317 

ruling on capital stock dis¬ 
counts, 332 

ruling on capital stock prem¬ 
iums, 331 

Inventories 
of merchandise, 171 
form, 180 

Investments, 261-291 
accountancy of, 280 
in bonds of other companies, 269 
income from, 299-301 
in real estate, 285-291 
form (ledger), 290 
in stocks of other companies, 
283-285 

interest purchased, 271 
mortgages as, 264 
of available funds, 261 
of surplus capital, 261 
permanent, 263 
policy of carrying, 289, 291 
securities as, 262, 263 
speculative, 261, 262 
temporary, 262 

J 

Journal, 84-109 

adjusting entries for trial bal¬ 
ance, 400 


cash (See “Cash Book”) 
development of journal system, 
85 

entries for capital stock, 324, 
325 

entries for earnings on invest¬ 
ments, 302-305 

example of single entry, 78, 79 
forms, 91, 92, 95-98, 100-102, 
105-108 

in double entry, 71, 74, 75 
in single entry, 75 
origin of, 84 

provides for controlling ac¬ 
counts, 127 

purchase (See “Purchase Jour¬ 
nal”) 

sales (See “Sales Journal”) 
segregation of accounts, 86-90 
specially ruled, 108, 109 
sub-journals, 85-90 

L 

Labor rates, 182 
Land and buildings, 221-230 
improvements on land, 222 
investments in land, 223 
land distinguished from build¬ 
ings, 221 

plant land, 221, 222 
Ledger, 110-130 
accounts on accrual basis, 303 
accounts with capital stock, 323* 
328 

“Bank,” in 
“Boston,” hi, 114-116 
form, 112-114 
card form, 118 
character of, no, in 
definition of, 124 
form of account, in 
general, 116, 117, 124 
loose-leaf form, 118 
private, 116, 117, 130 
reconstruction of, 125 


512 


INDEX 


Ledger —continued 
relation to private ledger, 117 
relation to subsidiary ledgers, 
130 

self-balancing form of, 129 
stock subscription, 46 
form of, 45 
structure of, no 
subsidiary, 124, 125, 129, 130, 267 
technique of posting, 121-123 
variant forms, in, 118 
voucher record as a, 118, 119 
Ledger, private 

as controlling general ledger, 130 
functions, 116 

relation to general ledger, 117 
Ledgers, subsidiary 
accountants’ views of, 130 
effect of keeping, 129 
for secured loans, form, 267 
posting to, 126 
purpose of, 124 

relation to general ledger, 124, 
128 

Legacies, 495 
Legal expenses, 260 
Liabilities 

accounts with, 134, 135, 137, 138 
and “accountabilities,” 320 
definitions of, 137 
different forms of, 137, 138 
for bond issue, 339 
of concerns about to liquidate, 
138 

of corporations, 29, 134 
of general partner, 21 
of going concerns, 137 
of limited partner, 21 
of stockholders, 31, 33, 41 
Liabilities accrued 
assessments, 364 
components of, 363 
license fees, 364 
taxes, 363-366 
when recorded, 363 


Licenses, 364 
Liens 

against partnership assets, 26 
on real estate, 286 
Life insurance companies, balance 
sheet for, 421-423 
Life-tenants, 279, 280 
Liquidation account (See “Ac¬ 
count”) 

Liquidation, voluntary 
closing books in, 474 
closing proprietors’ accounts in, 
474 

copartnership, 474 
corporation, 474 
treatment of surplus, 475 
Loans 
call, 268 

on bond and mortgage, 263, 264 
repayment of, 268 
secured, 266-269 
form, 267 

secured by collateral, 268 
securities pledged for, 268 
time, 268 

Logismography, 62, 80-82 
Losses from operations, 430 

M 

Machine rate, 183 
Machinery (See also “Tools”) 
accounts for, 239 
definition of, 238 
depreciation of, 241, 242 
distinguished from tools, 239 
special, 240, 241 
universal, 240 
Manufacturing concerns 
apportionment of overhead, 182- 

185 

cost sheet form, 180 
finished goods, accounts of, 175 
finished goods, inventories of, 
179 

general factory overhead, 175 


INDEX 


513 


Manufacturing concern s— con¬ 
tinued 

goods in process, accounts of, 
i /4 

goods in process, inventories of, 
179 

inventory of, without cost sys¬ 
tem, 179 

manufacturing burden of, 174 
manufacturing stages in, 173, 
174 

merchandise accounts of, 173- 

177 

merchandise inventories of, 176, 
1 77 

raw materials, accounts of, 173 
raw materials and supplies, in¬ 
ventories of, 177 
unproductive labor, accounts of, 
174 

Margin on loans, 268, 269 
Material rate, 183 
Merchandise accounts 
analysis of, 168 
debits and credits in, 165- 3 , 6 / 
discounts in, 167 
freight and cartage in, 167 
in single entry, 62, 64, 67 
inventories in, 171 
journal entries in, 169, 170 
of manufacturing concerns, 173- 

185 

of trading concerns, 165-167 
on cash basis, 300 
purpose of, 166 

relation to profit and loss, 170 
removal from journal, 86 
returned sales in, 166 
stock ledger for, 171 
form, 172 

subdivision of, 168-170 
Merchandise stock book, 171, 172 
Mines, 380 
Minute book, 44, 46 


Mortgages 

accounting procedure for, 265, 
266 

as collateral contracts, 264 
as permanent investments, 264, 
265 

as security for bonds, 337 
as security for loan, 266-268 
chattel, 348, 349 
considerations for, 346-348 
definition of, 264, 267 
foreclosure of, 264 
interest on, 265, 349 
Louisiana law, 346 
mortgagee’s rights under, 264 
real estate, 346 
register of, 265, 266 
validity of, 346 
Mortgagor, rights of, 347 

N 

Negotiable paper (See also “Notes 
Receivable”) 

contingent liability for, 161 
of partnerships, 26 
Nominal accounts, 132 
Non-stock corporations, 28 
Notes and bills journal 
character of, 99, 103, 104 
entries in, 103, 104 
forms, 101, 102 
value of, 103 
Notes payable, 350, 352 
Notes, promissory, 61, 350, 352 
Notes receivable, 158-164 
contingent liability for dis* 
counted, 159, 160 
dishonored, 161, 162 
effect on customer’s status, 158, 

159 

entries for, 103, 104 

entries for dishonored, 162, 163 

entries to maintain equilibrium, 

160 

in general ledger, 159 


514 


INDEX 


Notes receivable —continued 
journal for, 99, 103 
to what applied, 164 
treatment of, in accounts, 158- 
161 

O 

Obsolescence 
depreciation for, 372 
of machines, 241, 372 
Officers, corporate 
auditor, 43 
president, 42 
secretary, 42 
treasurer, 42 
vice-president, 42 
Operating reserves, 367, 368, 370 
Operations 
losses in, 430 
profits in, 430 

Organization expenses, 316-318 
Overhead expenses 
added to cost of construction, 
225 

apportionment of, 182-185 
components of, 439 
labor rate basis, 182 
machine rate basis, 183 
material basis, 183 

P 

Par 

in bond accounts, 270 * 

of stock, 29 
relation to cost, 272 
Partners 
advances by, 24 
claims against partnership, 25 
continuing, 27 
contributions of, 23, 24 
credits of, undrawn, 25 
debts incurred by, 24 
dormant, 21 

duties as to accounts, 25 
general, 20 


incoming, 27 
limited, 21 

litigation between, 23 
nominal, 22 
retiring, 26 

rights of surviving, 26 
special, 21 

status of retiring, 26 
Partnerships 

account with, before referee, 23 

articles of, 22 

Bankruptcy Act, 23 

capital accounts of, 383 

capital liability of, 321 

claims against, 25 

classes of, 20 

debts of, 25 

defined, 20 

effect of oral agreements, 24 
general, 20, 22 
good-will of, 26 
how regarded by courts, 23 
incoming partners, 27 
interest on advances, 25 
limited, 20, 22 
liquidating accounts of, 425 
negotiable paper of, 26 
obligations of, 26, 27 
procedure of claims against, 25 
property of, 24 
restrictions on, 20 
termination of, 22, 23, 25 
unapplied profits of, 382 
Patents 

accounting treatment of, 251-253 
as monopolies, 250, 251 
definition of, 250 
duration of, 251 
how written off, 252 
Patterns 

book value of, 236 
definition of, 236 
how written off, 236 
special, 236 




INDEX 


515 


Pay-roll journal 
forms, 105-107 
function of, 104 
loose-leaf form of, 109 
Peter Post problem, 481-490 
Petty cash 
definition of, 149 
how handled, 148, 149, 151 
imprest fund plan, 99, 151, 152 
journal entry for, 149 
nature of, 148 
Petty cash book 
as an independent record, 148 
forms, 100, 150, 153 
purpose of, 99 

relation to general cash, 99, 148 
Petty cashier, 149, 151, 152 
Pledge 

a form of security, 266 
as security for loan, 264, 266, 349 
differs from lien, 267, 268 
right of holder to sell, 267, 268, 
270 

value of, compared with loan, 
268, 269 

Pledgee, rights of, 268, 269 
Posting 
defined, 121 
method of, 121 
rules for, 122 
Potential stock, 29, 325 
Preferred stock, 30, 360 
defined, 30 

rights of, to surplus, 360 
Premiums 

amortization of bond, 273, 275 
bond, in interest account, 342, 

343 

deductions from principal, 343- 
345 

fire insurance, 309 
on bond sales, 341, 342 
on capital stock, 329-331 
Printing (See “Stationery”) 
Private ledger, 116, 117 


Profit and loss 

account with, in double entry, 73 
debits and credits to, 430 
discounts and premiums on bond 
sales in, 342 
in single entry, 66, 68 
in statement for steam roads, 
443 

statement of, 430-438 
Profits 

accountants’ view of, 229 
available for dividends, 359-361 
capital stock premiums as, 329- 
331 

from operations, 430 
of corporations, 30 
of partnerships, 382 
Promissory notes, 61, 350, 352 
Property 

acquired by stock issue, 32 
appraisal of corporate, 32 
partnership, 24 
taxable, 365 
taxes on, 365 
Proprietorship accounts 
drawing, 381-383 
positive and negative compo¬ 
nents of; 380, 381, 383 
unapplied profits, 382 
undivided profits, 382 
Proprietor, sole 
drawing account of, 381-383 
laws affecting, 319 
relation to assets of business, 
320, 321, 380 

Public Service Commission 
definition of additions, 228 
definition of betterments, 228 
definition of renewals, 228 
definition of repairs, 229 
definition of replacements, 229 
general powers of, 429 
ruling on balance sheets, 429 
ruling on organization expenses, 
317 


INDEX 


516 

Purchase journal 
derived from original journal, 
85-88 

forms, 91, 92 

for “returned” purchases, 90 
functions of, 90 
Purchasing department 
activities of, 90 
records of, 90 

R 

Railroads, steam 
balance sheet for, 424-428 
Real estate 

accounting for investments in, 
287-291 

components of cost of, 289 
investments in, 285-291 
Realization account (See “Ac¬ 
count”) 

Receipts, warehouse, 350 
Records, corporate 
corporate journal, 48 
forms, 49, 51 
minute book, 44, 46 
of capital stock, 323-328 
statutory requirements, 44 
stock book (ledger), 48 
forms, 49, 50 
stock certificate book, 46 
forms, 46, 47 
stock transfer book, 52 
form, 53 

subscription ledger, 46 
form, 45 

Redemption fund 

distinct from sinking fund, 298 
for premium on bonds, 277 
Registers of checks, 143, 147 
form, 140 

Remaindermen, 279, 280 
Renewals defined, 228 
Rent, as cost element, 439 
Repairs defined, 229 
Replacements defined, 229 


Reserve funds, 293 
Reserves 
as assets, 293 
as deferred debits, 293 
classes of, 295 

distinguished from surplus, 369 
for depreciation, 295, 37 1 “373. 
378 

for exhaustion of physical as¬ 
sets, 377, 378, 380 
for redemption of debt, 370, 

374 , 375 

for surplus contingencies, 370, 

373 , 374 
funded, 293 
how created, 293-295 
Interstate Commerce Commis¬ 
sion on, 293, 295 
methods of creating, 376, 378 
operating, 367, 368, 370 
secret, 370, 373 

S 

Salaries of salesmen, 395 
Sales, conditional 
of commission merchant, 198, 

199 

of partnerships, 26 
Sales department 
books for, 93 
statistics for, 93 
Sales journal 
forms, 94, 95 
functions of, 90, 93 
origin of, 86-88 
Securities 

accounting treatment of, 262 
as temporary investments, 262 
collateral, 268, 269 
concurrent, 266 
for speculative purposes, 262 
kinds of, 266 
nature of, 266 
Self-balancing ledger, 129 


INDEX 


51/ 


Shares 

functions of, 319, 320 
par value of, 29 
purpose of, 29 
Shipments inward, 186-207 
accounting methods for, 189- 
207 

consignee’s account illustrated, 
193 

consignee’s trial balance, 198 
factor’s accounts and books, 
189-192, 200 
forms, 201, 202 
journal entries for, 194-197 
occasional consignments, 203 
Shipments outward, 208-220 
accounting methods for, 208 
first accounting method, 209-211 
form, 218 

journal entries for, 209, 210, 
211-215 

ledger accounts with, 216-218 
memorandum for, 218 
second accounting method, 211- 

213 

third accounting method, 213- 
220 

Single-entry system, 54-68 
basic principles, 54, 55 
books required in, 67, 68 
cash disbursements, 61 
cash receipts, 60, 61 
charge sales, 60 
closing accounts in, 62 
debits and credits in, 55-57 
financial statements based on, 
67, 384-395 

gains and losses in, 58, 59 
journal in, 75 
ledger accounts, 55, 57, 62 
profit and loss account in, 68 
promissory notes, 61 
proprietor’s account, 56-62 
trial balance in, 68 
Sinking fund rule, 280 


Sinking funds 
accounting theory of, 298 
as redemption fund, 298 
company bonds in, 340, 341 
methods of creating, 296, 297, 
298 

Sole proprietorship (See “Pro¬ 
prietor, sole”) 

Specific funds (See “Funds”) 
Statement of affairs, 461-473 
arrangement of, 473 
asset side of, 463, 469 
deficiency account, 471-473 
arrangement of, 473 
forms, 464, 465 
liability side of, 463, 470 
occasion for, 461 
preparation of, 466 
status of, 461-463 
Statement, financial 
account form of, 441, 442 
based on single entry, 67, 384- 
395 

elements of, 430-432 
for interstate steam roads, 442- 
445 

mechanism of, 432-437 
of assets and liabilities, 384 
of cash receipts and disburse¬ 
ments, 445, 446 

of income and profit and loss, 
386, 430-437 

Stationery and printing 
accounts for, 314 
as assets, 311, 312 
Statmography, 62, 82, 83 
Stock book (ledger), 48 
form of, 49, 50 

Stock, capital (See also “Shares”) 
as a liability, 320 
balance account of, 48 
common, 30, 360 
distinguished from capital, 29 
forfeiture of, 32 
in balance sheet, 328 


INDEX 


1518 

Stock, capital —continued 
increase of, 33 
issued as a bonus, 33 
issued for labor or services, 33 
issued for property, 32 
of other companies as invest¬ 
ments, 283 
potential, 29, 325 
preferred, 30, 360 
premiums on, 329-331 
records of, 323-328 
reduction of, 33 
treasury, 332-334 
unissued, status of, 329 
Stock certificate book, 46 
forms, 46, 47 
Stock corporations, 29 
Stockholders 

common-law rights of, 41 
liability of, 31, 33, 41 
voting rights of, 30 
Stock journal, 48 
form, 49, 51 
Stock transfer book, 53 
form, 52 

Sub-journals, 85-90 
Subscriptions, stock 
forms of, 45 
payments on, 32 
unconditional, 31 
Subsidiary ledger, 124, 125 
Supplies 
advertising, 311 
stable, 311, 313 
stationery, 311, 314 
Surplus 

court ruling on distribution of, 
360 

distinguished from reserves, 369 
distribution of, 360 
in financial statement, 433 
of banks, 30 
of corporations, 30 


T 

Taxes 

business, 365 
classification of, 364 
date of liability for, 363 
defined, 364 
excise, 365 
federal, 364 
inheritance, 366 
municipal, 364 
property, 365 
state, 364 

on real estate, 286, 287 
Titles to real estate, 286 
Tools (See also “Machinery”) 
accounts for, 239 
distinguished from machines, 
238 

machine, 238, 239 
shop and hand, 238, 242 
Trade discounts, 155 
Trade-marks 

court rulings on, 253, 254 
definition of, 253 
infringement of, 254 
treatment on books, 254 
use of, 253 
value of, 254 

Transportation equipment, 235 
Treasurer’s department 
cash journal for, 94, 99 
information required by, 94 
memorandum book of available 
cash, 144 
form, 148 
Treasury stock 

accounting for, 333, 334 
definition of, 333 
“donation” account with, 334 
legal view of, 332 
Trial balance 
classified form, 396 
defined, 396 
of consignee, 193, 198 


INDEX 


Trial balance —continued 
posting journal entries from, 

400 

Trust funds, 280 
V 

Values defined, in single entry, 

57 

Voucher record 
defects of, 118, 120 
form, 119 

mechanism of, 118 


519 

of expenses and payments, 143 
origin of, 118 
Vouchers 

audited and unpaid, 147, 355 
ledger account with, 143, 144 


Warehouse receipts 
as security, 350 
defined, 350 
negotiable, 350 

Working balance sheet, 396-405 












Practical Problems 

To Accompany “The Applied Theory of Accounts’* 


PROBLEM I 

To illustrate the general principles of corporation ac 
counting, and particularly the mechanism of the corporate 
journal. (See Chapters III, IV.) 

The Goldengate Mining Company has been incorporated 
to extract silver from veins located in Mexico. The capital 
stock of the company, which is divided into 30,000 shares 
of common stock of the par value of $10 per share, is issued 
March 1, 1916, as follows: 


To A. Rosenberger, Incorporator, for cash @ par, 50 shares, cert. No. i 


“ B. Rothschild, 

II 

if if ll if 

II 

II 

“ 2 

“ C. Silverstein, 

II 

11 11 ii i< 

II 

II 

“ 3 

“ D. Gangloff 

If 

II II II II 

II 

II 

“ 4 


“ John Skeener, Vendor, for land 

purchased.29,800 shares, cert’s Nos. 5 to 302 

On March 4, 1916, John Skeener donates to the com¬ 
pany certificates numbers 5 to 204, which are to be placed 
in the treasury, and sold to acquire working capital. Dur¬ 
ing March and April, the following stock transactions occur: 


March 5, 

Sold out of treasury to John Doe. 



II 

II 

II 

“ “ V. Roe. 

... 500 

“ “ $8.50 

March 7, 

II 

II 

II 

“ “ Y. Kalisher.... 

400 

“ $8.60 


II 

II 

II 

“ “ Peter Henry... 

... 5,000 

“ “ $8.70 

April 1, 

II 

II 

II 

“ “ John Sidney.... 

700 

“ “ $8.75 

April 15, 

<1 

II 

II 

“ “ Bankers’Union Inc. 12,400 

20,000 

“ “ $8.80 


521 














5 22 


PRACTICAL PROBLEMS 


During the same period, the following transfer notices 
have been received by the company: 

March 12, Sold by John Doe to Henry 

Doe. 500 shares, cert’s Nos. 303-7* 

24, “ “ Peter Henry to A. 

Arnold .2,000 “ “ “ 322-41 

April 20, “ “ Bankers’ Union to 

Miners’ Bank.6,000 “ “ “ 404-63 

Required: 

The recording of the above facts on the corporate 
stock journal of the Goldengate Mining Company. 

*New certificate numbers are to be provided for the issue of treasury stock 
and for exchanges. 


PROBLEM II 

To illustrate the principles of accounting involved in 
recording the transactions incident to the organisation of a 
corporation, and the mechanism of corporate accounting 
records. (See Chapter IV.) 

At a meeting held on January 25, 1916, the incorpora¬ 
tors of the Carlton Manufacturing Company approve the 
articles of incorporation of the company drawn by counsel 
in accordance with the corporation laws of New Jersey. The 
stock subscription book is signed by them as follows: 



Name 

Shares 

Amount 





Paid 


H. 

R. Pitt. 


25% (Paid by check) 

R. 

V. Carson. 

. 20 

25% 

it it 

H. 

St. John. 

. 20 

25% 

a it 

S. 

Verner. 

. 20 

25% 

a a 

Y. 

Lucas. 


25% 

11 11 












PRACTICAL PROBLEMS 


5 2 3 


The articles of incorporation are filed February i, 1916, 
with the Secretary of State and the county clerk, the in¬ 
corporators paying fees of $210 for filing and incorporat¬ 
ing. The authorized capital stock is $1,000,000, divided 
into shares of $100 par value. 

Between January 25 and February 1, the incorporators 
obtain from four prominent financiers, subscriptions to 4,000 
shares of stock, each subscriber agreeing to take 1,000 
shares; the condition of the subscription is that 25% shall 
be paid in cash upon subscribing, and 25% on the first of 
every month thereafter, until the stock is fully paid. At a 
meeting of the stockholders, held February 10, the incor¬ 
porators are elected directors. The directors hold their first 
meeting on February 11, and accept John Doe’s proposition 
to sell to the company a suitable factory, ready for opera¬ 
tion, together with the land on which it stands, and the ma¬ 
chinery and equipment which it contains, for the sum of 
$690,000. 

The conditions of the settlement to be made by the com¬ 
pany are as follows: 

John Doe, vendor, is to receive: 

% 

1. Capital stock, $490,000. 

2. Purchase money mortgage, covering land, building, 

and equipment, present or to be acquired, bearing 
interest at 6%, payable semiannually, the mort¬ 
gage dated February 1, 1916, due February 1, 
1921. Amount of mortgage, $150,000. 

3-. Two promissory notes of $25,000 each, bearing in¬ 
terest at 6%, and due, one, five months after 
February 1, 1916, the other, seven months after 
February 1, 1916. 

During the period from February 1 to May 10, 1916, 
the Carlton Manufacturing Company has collected all 


5 2 4 


PRACTICAL PROBLEMS 


moneys receivable on account of subscriptions to stock, and 
on May 2, 1916, has issued the stock subscribed. From the 
stock still unissued 975 shares are issued the same day 
(May 2), at par, to H. B. Turner, contractor, in settlement 
of extensions and alterations made by him to the factory 
building. 

The certificates of stock issued are as follows: 




No. of 

No. of 


Date 

Name 

Cert. 

Shares 


Feb. 11, 1916 

John Doe . 

1-49 

100 (in each cert.) 

May 2, 1916 

H. R. Pitt. 

90 

20 



R. V. Carson. 

9 i 

20 



H. St. John. 

92 

20 



S. Verner. 

94 

20 



Y. Lucas. 

93 

20 



J. Smith. 

• 50-59 

100 (in each cert.) 


Wm. Jones. 

. 60-69 

100 

<1 


James Brown . 

. 70-79 

100 

11 


Robert Decker . 

. 80-89 

100 

11 


H. B. Turner. 

• 95-103 

100 

11 


<< a n 

. 104-106 

20 

11 


u i( it 

. 107-109 

5 

11 

On May 

10, John Archbold, 

counsel 

for the 

company, 


presents a bill for legal services and expenses in connection 
with the organization of the company for $2,500, and agrees 
to accept in payment therefor, 25 shares of stock at par. 
Accordingly, the following stock certificates are issued to 
him: 


No. no 20 shares 


Required: 

The recording of the above stock transactions in a 
properly ruled stock book. A “Capital Stock Is¬ 
sued Controlling Account’’ must be kept. 

















PRACTICAL PROBLEMS 


525 


PROBLEM III 


Based on single-entry principles. (See Chapter V.) 

John Armstrong is engaged in wholesale trading. 

His ledger, opened by a local bookkeeper, is based on 
the single-entry system, and, at December 31, 1916, that 
is to say, at the end of the first year’s business, discloses the 
following facts: 


Due from Customers (as per schedule).$ 995.00 

Due to Creditors ( “ “ “ ). 1,800.00 

John Armstrong, Capital Account (unchanged throughout 
year). 8,000.00 


A single-entry journal and a check book are the only 
other records kept by John Armstrong. 

The physical inventory taken on December 31, totals 

$3,450. 

You are asked to ascertain the present worth of the 
business, and the extent of the increase of the proprietor’s 
worth during the year. 

After a preliminary examination of the records, and a 
consultation with the proprietor, you find the following as 
at December 31, 1916: 


Cash in Bank. 

Cash in Store. 

Notes Receivable (all transactions in December, 1916). 

Notes Payable (all transactions in December, 1916). 

First Mortgage on Real Estate and Building*. 

Cost of Land and Building. 1 Acquired prior to Jan- 

Cost of Furniture and Fixtures., uary 1, 1916, with a view- 
Cost of Delivery Equipment I of engaging in business. 


$3,320.00 
150.00 
50.00 
2,000.00 
2,500.00 
' 6,000.00 
91500 
750.00 


*Given before January i, 1916. 


From the foregoing facts, prepare: 

A statement of assets and liabilities at January i, 1916, 















526 


PRACTICAL PROBLEMS 


and at December 31, 1916, showing the net increase of 
capital for the year, as determined by the asset and liability 
method. 


PROBLEM IV 

Based on the application of the principles of double entry 
to the construction of ledger accounts and introducing the 
legal theory of consignments inward. (Sec Chapter XVII.) 


The general balance sheet of Armstrong & Campbell at 
March 31, 1916, shows: 


Assets 


Liabilities 


Land and Building. 

$6,000.00 

1st Mortgage 6%, 1918.. 

$2,500.00 

Furniture and Fixtures.. 

91500 

Notes Pavable. 

*3,150.00 

Transportation Equip- 


Accounts Payable. 

17,894.80 

ment. 

1,550.00 

Reserve for Good-Will.. 

1,000.00 

Good-Will. 

1,000.00 

John Armstrong, Capital 

13,41513 

Merchandise Inventories 

22,890.00 

A. Campbell, Capital.... 

ii, 599-62 

Cash. 

10 , 955-75 



Notes Receivable. 

*1,750.00 



Accounts Receivable.... 

4,200.00 



Freight and Expenses on 




Consignment No. 1.... 

120.60 



Freight and Expenses on 




Consignment No. 2_ 

130.00 



Freight and Expenses on 




Consignment No. 3_ 

48.20 



$ 49 , 559-55 


$ 49 , 559-55 


*A 11 to run 90 days from date of issue; received or issued in March, 1916. 


In accordance with the requirements of their articles of 
copartnership, Armstrong & Campbell took a physical in¬ 
ventory on June 30, 1916. It disclosed, figured at cost, ex- 



















PRACTICAL PROBLEMS 


5 2 7 

elusive of freight: merchandise, $59,843.04; consignments 
No. 1, $1,500; No. 2, $1,900; No. 3, $51.80. 

In connection with consignments, the firm has decided 
to settle for sales to date by checks drawn June 30, 1916, 
on the banking house of Brown, Smith & Co., London, 
with whom they deposited $12,000 on June 1, 1916. Under 
the terms of the consignments, 10% is to be allowed to the 
consignees, and the consignors are to be charged with all 
expenses for freight and cartage, for allowances on defec¬ 
tive goods, and for trade discounts. An account sales is to 
be forwarded with each remittance. All the sales made by 
Armstrong & Campbell for the account of the consignors 
have been paid for by customers at June 30, 1916. 

The inventory pricing has not taken into consideration 
freight on goods received and not sold ; so far as you can 
ascertain, said freight amounts to $377.80. 

The bookkeeper submits the following trial balance and 
explains that he has closed the consignment accounts, as this 
was necessary to ascertain the amount of remittances to be 
made. With this exception, the trial balance is before 
closing: 


Trial Balance, June 30, 1916 


Brown, Smith & Co., 

London. $1,198.01 

Land and Building. 6,000.00 

Furniture and Fixtures 975-°° 
Transportation Equip¬ 
ment . 3,150.00 

Cash . 24,93413 

Notes Receivable. 12,000.00 

Good-Will. 1,000.00 

Freight and Cartage 

Outward. 3 IO -5° 

Heat and Light. 30.80 

Stable Expenses. 350.00 


Notes Payable. 

$30,000.00 

Accounts Payable. 

49,701.74 

1st Mortgage Payable.. 

2,500.00 

Consignment No. i.... 

1,500.00 

“ “2.... 

1,900.00 

ii << ~ 

O • • * * 

51.80 

Interest, Banks. 

75.60 

Reserve for Good-Will 

1,000.00 

Commissions — Con- 


signed Goods. 

1,264.8 2 

J. Armstrong, Capital.. 

I34I5-I3 

A. Campbell, Capital... 

11,599.62 



















528 


PRACTICAL PROBLEMS 


Trial Balance— Continued 


Salaries — Clerks. 

500.00 



Partners .... 

300.00 



Salesmen .... 

900.00 



Sundry Expense—Store 

210.50 



Commissions — Sales- 




men. 

1,850.70 



Consignment No. 1_ 

1,500.00 



“ “2_ 

1,900.00 



it it ~ 

O • • • • 

51.80 



Accounts Receivable.... 

19,388.84 



Merchandise . 

35 , 508.43 



J. Armstrong — Draw- 




ings. 

450.00 



A. Campbell — Drawings 

500.00 



Total . $113,008.71 

Total. 

.$113,008.71 


The transactions of the period under review are as 
follows: 

Merchandise 

0 

Purchases, $128,020.26; sales, $118,066.85; freight in, 
$2,540.71; allowances on defective sales, $1,555.11; allow¬ 
ances on defective purchases, $1,521.29; trade discounts 
from creditors, $4,645.93; trade discounts, customers, 
$1,781.70; sales returned, $5,930.90; purchases returned, 
$2,725.50; freight refunded on purchases returned, 
$250.68. 

Consignment Debits 

Sales value of goods consigned March, 1916: No. I, 
$10,100; No. 2, $5,000; No. 3, $1,000. Freight, insurance, 
etc., March, 1916: No. 1, $120.60; No. 2, $130.00; No. 3, 
$48.20. Freight on sales: No. 1, $138.60; No. 2, $60.10; 
No. 3, $40.50. Allowances to customers for defective goods: 
No. 1, $14.16; No. 2, $8.20; No. 3, $21.03. 




















PRACTICAL PROBLEMS 


529 


Consignment Credits 

Sales: No. 1, $8,600; No. 2, $3,100; No. 3, $948.20. 
Freight and allowances charged to consignors: No. 1, 
$273.36; No. 2, $198.30; No. 3, $109.73. 

From the foregoing prepare ledger accounts: Cash, Ac¬ 
counts Receivable, Accounts Payable, and all the 
ledger accounts affected by the consignment transac¬ 
tion. 


PROBLEM V 

To illustrate the working of the theory of agents' ac¬ 
counts as indicated by the requirements of the law of agency. 
Adapted from the New York C. P. A. Examination of 
January, 1913* (See Chapter XVII.) 

Karl Smith is a real estate broker and agent who, among 
other things, manages properties in consideration of com¬ 
missions, ranging from 3% to 5% on rent collections. For 
the last two years his books have been kept in haphazard 
fashion and in violation of the law of agency. They are 
incomplete as to footings and postings; no trial balance of 
the general ledger has been obtained and no reconciliation 
of bank balances has been established during the above 
mentioned period. The tenants rent book is a species of 
“tickler” in which the current rent charges are entered in 
pencil and inked in when paid; the names of the tenants of 
properties not leased are also entered in pencil and erased 
when tenants move, the new names being entered in the 
places thus left vacant. 

*The requirements of this problem have been changed to suit present needs; 
one of the original requirements being essentially an auditing test. 




530 


PRACTICAL PROBLEMS 


Having accidentally discovered irregularities in the ten¬ 
ants book, Karl Smith has discharged his bookkeeper- 
cashier and engaged an accountant to conduct an examina¬ 
tion of his books, records, and accounts, discover the extent 
of the shortage, which he fears is considerable, and instal 
a new system of accounts. 

After spending considerable time in an attempt to place 
the books on an accounting basis, the accountant finally 
obtains the following trial balance of the ledger, as of Sep¬ 
tember 30, 1916, instals a new system which will permit his 
client to fulfill his accounting duty as an agent, and renders 
a preliminary report accompanied by a statement, showing 
clearly the financial status and the relations of Karl Smith 
to his principals : * 


Trial Balance 


Cash. 

• • $350.20 

Karl Smith, Capital. 

.... $4,360.40 

Petty Cash. 

100.00 

Commissions. 

-22,510.00 

The Augusta Terrace 

215.00 

Phoenix Insurance Co... 470.00 

“ Victoria Court.. 

805.00 

London Insurance Co... 450.10 

“ St. Quentin Court 

d a ) 650.00 

The F rederic Apart- ^ 


“ Audubon Court.. 

270.00 

ment. 

2,385.30 

“ Evening Despatch 

75-00 

“ Venetian Court 

-(f) 2,500.00 

“ Morning News.. 

35-00 

“ Franklin Castle 

3,231.00 

“ Union Wall Paper 


St. Martin Hall.... 

2,850.70 

Co. 

(k) 111.20 

Tenants. 


“ Janitors’ Supplies 




Co. 

45-25 



Insurance Account... (c) 920.10 



Karl Smith, Drawings (d) 16,930.00 



Cash Shortage.(e) 380.00 



Salaries. 

.. 12,140.00 



Office Expense. 

- - 3,130.00 



Furniture and Equip- 



ment. 

• • 4 , 150.75 




$40,30750 


$ 40,30750 





























PRACTICAL PROBLEMS 


531 


Notation by the accountant: 

(a) Remittances on account of collection of October 

rents, paid in advance upon signing lease, not 
as yet credited to the principals. Settlements 
to be made on the 29th of every month. 

(b) Balances representing payments from March to 

June, 1916, for advertising, decorating and 
supplies, for the account of managed prop¬ 
erties. Paid bills cannot be found; no details 
available; itemized receipted bills asked for by 
letter ; no answer at September 30, 1916. 

(c) Premiums on fire insurance placed by agent for 

account of sundry clients not principals. 
Premiums will be paid to agent if risk is ac¬ 
cepted and he will deduct commissions of from 
5% to 15% from settlement with companies. 

(d) Probably contains charges which might properly 

be capitalized under caption “Furniture and 
Fixtures” if positive information were 
available. 

(e) Entries made in cash book by accountant for rent 

collections appearing in monthly statements to 
principals, but not appearing in cash book nor 
in duplicate of bank deposits obtained from 
banks. 

(f) According to the terms of his employment the 

agent must remit on the fifth day in every 
month. 

Prepare the trial balance of the general ledger of Karl 
Smith as corrected by the accountant. Divide the said 
statement into two distinct parts, one showing what belongs 
to the agent, the other showing what belongs to the 
principals. 


532 


PRACTICAL PROBLEMS 


PROBLEM VI 

To illustrate one of the methods of passing from the 
copartnership to corporation, and the recording of the trans¬ 
actions incident thereto. (See Chapter XXII.) 

The Smithers-Jones Company is incorporated under the 
laws of the State of New York to acquire and conduct the 
business of the firm of H. B. Smithers and T. Jones. The 
authorized capital stock of the company is $800,000, di¬ 
vided into $450,000 of preferred stock and $350,000 of 
common stock, of the par value of $100 per share for both 
stocks. The preferred stock is entitled to receive a 7% 
dividend before any dividends are paid to common stock; 
but after the latter has received an equal dividend, both 
classes of stock shall participate equally in the balance of 
surplus declared as dividends to be distributed. The pre¬ 
ferred stock is preferred as to assets. 

The following assets and liabilities of Smithers and 
Jones, acquired and assumed by the Smithers-Jones Com¬ 
pany, appear on the books of the vendor at January 31, 
1917: 


Assets 


Liabilities 


Land. 

$50,000.00 

Mortgage Payable. 

$32,500.00 

Building. 

150,000.00 

Accounts Payable. 

110,023.00 

Transportation Equip- 


Notes Payable. 

16,500.00 

ment. 

10,000.00 

Reserve for Deprecia- 


Furniture and Fixtures 

5,000.00 

tion of Physical 

Machinery and Tools.. 

72,000.00 

Property. 

51,300.00 

Goods in Process. 

68,195.00 

Capital of Partners. 

350,000.00 

Finished Goods. 

51,830.00 



Materials and Supplies 

22,650.00 



Accounts Receivable... 

114,648.00 



Notes Receivable. 

16,000.00 



$560,323.00 


$560,323.00 





















PRACTICAL PROBLEMS 


533 


The price which the corporation has agreed to pay for 
the properties taken over is $500,000, which is to be paid 
in stock of the corporation to the three partners of the 
vendor firm in the proportion in which they have divided 
their profits in the past, i.e., H. B. Smithers, % ; T. Jones, 
^5; X. Vreeland, }i. 

The stock is issued on February 2, 1917, and at their 
meeting of February 15, 1917, the directors of the com¬ 
pany decide to carry the value of the land at $70,000; the 
building at $160,000; the transportation equipment at 
$13,000; the furniture and fixtures at $7,000; the machinery 
and tools at $80,000 ; these increases are based on the pres¬ 
ent replacement value of the properties affected. The re¬ 
serve for depreciation is to be carried at a figure decreased 
in the amount of the increases of the book value of the 
physical assets other than land. 

The balance of the purchase price is to be set up as good¬ 
will, to cover the firm’s name and the good-will it conveys, 
in addition to trade-marks and patents written off by the 
copartnership in the last five years to the extent of $17,000, 
their original value. 

% 

Required: 

Explicit journal entries recording the above facts on 
the books of the Smithers-Jones Company. 


PROBLEM VII 

To illustrate a second method of passing from copartner¬ 
ship to corporation, and the recording of the transactions 
incident thereto on the hooks of the vendee and the vendor. 
(See Chapter XXII.) 



534 


PRACTICAL PROBLEMS 


The firm of Bowman & Turner, including J. Vermont 
as a silent partner, decides to sell out to the International 
Novelty Company, which the partners have incorporated 
with an authorized capital stock of $200,000, divided into 
700 shares of 6% cumulative non-voting preferred stock, 
and 1,300 shares of common voting stock, all of the par 
value of $100 per share. The preferred stock is preferred 
as to assets. 

The contract of sale refers only to fixed assets and work¬ 
ing and trading assets, the copartnership having agreed to 
liquidate its current liabilities. The balance sheet of the 
vendor firm shows at September 30, 1916: 


Cash . 

$11,254.00 

Accounts Payable... 

• •• $ 45,63540 

Accounts Receivable... 

39,616.00 

Notes Payable. 

... 11,000.00 

Notes Receivable. 

7,000.00 

Wages Payable. 

1,234.60 

Finished Goods. 

5,320.00 

T. S. Bowman. 

... 75,000.00 

Goods in Process. 

20,040.00 

S. D. Turner. 

... 45,000.00 

Materials and Supplies 

25,600.00 

J. Vermont. 


Furniture and Fixtures 

3,800.00 



Shop Tools. 

6,540.00 



Machinery and Machine 




Tools. 

38,700.00 



Land, Factory, and 




Equipment. 

60,000.00 



$217,870.00 


$217,870.00 


The price agreed upon as between the copartnership and 
the corporation is $194,000, which is subject to the follow¬ 
ing agreement: 

J. Vermont, special partner, whose investment has, in 
the past, netted him 6 % per annum, will receive 6 % non¬ 
voting preferred stock; T. S. Bowman and S. D. Turner 
are to have equality in the management of the corporation. 
The excess price to be paid by the corporation over the net 
worth of the assets transferred by the copartnership is to 























PRACTICAL PROBLEMS 


535 


be settled in bonds of the denomination of $500 each, due 
T 93 2 > bearing interest at 6%, interest and principal to be 
secured by a mortgage on all the property and equipment. 
The general partners only are to share in the salable value 
of the good-will. 

Required: 

1. The expression, in journal entry form, of such of 

the above facts as concern the corporation. 

2. The journal entries necessary to close the books of 

the copartnership. 


PROBLEM VIII 


To illustrate the effect of careless accounting upon the 
hooks of corporations which have been created for the pur¬ 
chase of copartnerships. (See Chapter XXII.) 

A and B were copartners in a newspaper publishing 
business, sharing profits and losses equally. A trial balance 
of their general ledger at December 31, 1916, was as 
follows: 


Operating Expenses (less earnings). $1,343-89 

A’s Investment Account (representing losses over 

and above capital contributed). 1,519-79 

B’s Investment Account (representing losses over 

and above capital contributed). 1,519.78 

A’s Loan Account. 

B’s Loan Account. 

General Expenses. 281.06 

Accounts Receivable. 2,012.14 

Cash. 273.01 


$6,839.31 

110.36 


$6,949.67 $6,949-67 

















536 


PRACTICAL PROBLEMS 


A and B agreed to sell to the Daily Star Publishing 
Company, a New York corporation, as of January i, 1917* 
the newspaper published by them, together with all the 
assets of their publishing business in consideration of 45 
shares, par value $100 each, of the company’s capital stock 
(total issue* $5,000) and $500 in cash, the company to as¬ 
sume all the outstanding liabilities of the business carried 
on by A and B. 

No new books were opened for the corporation, the 
books of the partnership having been retained as suitable 
for the corporate body. No journal entries relating to the 
assets acquired, liabilities assumed, and capital stock issued, 
were made. Prior to the establishment of the above trial 
balance, the company received a check for $500 from one 
of the incorporators, in payment of subscribers’ shares, 
which was credited in error to A’s loan account. The pay¬ 
ment of $500 in cash to A and B as part consideration of 
the business purchased has not been made. Amounts of 
$6,839.31 and $110.36 due to A and B, respectively, are to 
be considered as liabilities of the corporation. The debit 
balances in A’s and B’s investment accounts and the operat¬ 
ing and general expenses shown above, were closed out to 
profit and loss on the books of the company in subsequent 
periods. 

Required: 

1. The journal entries necessary to correct the books 

of the corporation in respect of its capital stock 
and other accounts; express the facts in view of 
a possible lawsuit involving your taking the 
stand as a witness. 

2. The trial balance of the books as adjusted by you. 

3. All the ledger accounts affected by your adjust¬ 

ments. 


PRACTICAL PROBLEMS 


537 


PROBLEM IX 

To illustrate the recording of certain phases of corpora¬ 
tion finance, and the difficulty of giving accounting expres¬ 
sion to careless resolutions of hoards of directors. (See 
Chapter XXII.) 

Two-thirds of the stockholders of the Precision Ma¬ 
chine Company, incorporated under the laws of the State 
of New York, have consented to an issue of bonds by the 
company. Accordingly, on January 5, 1916, they pass 
resolutions authorizing the issue, and define the amount, 
denomination, interest rate, and terms of the bonds, as 
follows: 

200 bonds of $1,000 each, dated January 1, 1916, due 
December 31, 1922, bearing interest at 4 1 /2%, pay¬ 
able annually on December 31; amount of bonds, 
$200,000. 

200 bonds of $500 each, dated January 1, 1916, due 
December 31, 1924, bearing interest at 4 ^ 4 %, pay¬ 
able annually on December 31; amount of bonds, 
$100,000. 

200 bonds of $500 each, dated January 1, 1916, due 
December 31, 1928, bearing interest at 5%, payable 
annually on December 31; amount otf bonds, 
$100,000. 

The bonds are secured by a blanket mortgage on the 
land, factory buildings, factory equipment, and materials 
and supplies, the conditions of the indenture being such that, 
as soon as one of the issues of bonds is retired, th£ share of 
the mortgage securing it will apply to the unretired issues 
of January 1, 1916. The indenture contains a clause relat¬ 
ing to the creation of a sinking fund out of annual profits 
for the redemption of bonds at maturity. 


538 


PRACTICAL PROBLEMS 


In order that the sinking fund provision of the indenture 
may be properly carried out, the directors of the company, 
at a meeting held January 8, 1916, resolve that there shall 
be charged annually to profits as ascertained at December 
31, an amount representing 1/7, 1/9, and 1/13 of the par 
value of the bonds issued, less the amount of interest earned 
by the sinking fund during the prior period; that an amount 
of cash equal to the amount of the reserve shall be set aside 
annually, and deposited with a trust company at interest; 
that the interest earned by the fund shall be deposited with 
the fund and credited to revenue. The board denies itself 
the right to use the sinking fund for any purposes other 
than that for which it is created. 

The board, at the same meeting, resolves that the dis¬ 
count and premiums which may be lost or gained on the 
sales of bonds shall be amortized in equal yearly amounts, 
throughout the life of the bonds. 

The bonds were sold during January, 1916, as fol¬ 
lows: 

Issue of 4^2% bonds due 1922, sold at 99 

“ “ 434 % “ “ 1924, “ “ par 

“ “ 5% “ “ 1928, “ “ 103 

The trust company with which the sinking fund is to 
be deposited, has agreed to pay thereon 4% interest 
annually. 

Required: 

1. The cash book entries for the two years ended De¬ 

cember 31, 1916, and December 31, 1917, 

giving expression to the facts recited by the 
problem. 

2. The journal entries, for the same period, affecting 

the sinking fund provision of the indenture, and 
the amortization. 


PRACTICAL PROBLEMS 


539 


PROBLEM X 

From New York C. P. A. Examination of January, 
1914 .* (See Chapter XXIII.) 

An investment bond house purchases 10 New Jersey 
Traction Company first mortgage 5% bonds at 83 * 4 ; 10 
New Orleans Gas Light and Power Company first mort¬ 
gage 5% bonds at 104 (accrued interest is not to be 
considered). 

Prepare the necessary entries to record properly these 
transactions on the books of the bond house. 


PROBLEM XI 

From New York C. P. A. Examination of January, 
1914. (See Chapter XXIV.) 

A trust company assumes the responsibility of a sinking 
fund on which it guarantees to pay 3% interest. The 
trustee receives $103,000 deposited to the credit of the sink¬ 
ing fund, and on January 1, 1911, invests on a 3% basis in 
100 Clair County Light, Heat & Power Company 5 °/o 
$1,000 first mortgage gold bonds, due July 1, 1912, interest 
payable semiannually. 

Prepare the accounts of the trust company, showing 
the invested amount and the amortization of the premiums 
at the several interest periods. 


•Auditing requirements left out. 




540 


PRACTICAL PROBLEMS 


PROBLEM XII 


Showing the effect which the ignorance of the theory of 
accounts has upon accounting results. Adapted from prac¬ 
tical problem in New York C. P. A. Examination of 
June, ipi2. (See Chapter XXV.) 

The books of Vincent Armstrong at June 30, 1916, 
show the following: 


Debits 


Cash . $9,800.00 

Real Estate. 3,000.00 

Office Furniture. 1,095.00 


Investments, Stocks .... 7,650.00 

Bonds _ 2,300.00 

“ Margin Ac¬ 

count ... 12,000.00 

Receivable Accounts_ 16,000.00 

Expense Account.... (f) 9,700.00 

Interest.(g) 1,085.30 


$62,630.30 


Credits 

Brooklyn Terminal Co., 

.(a) $3,000.00 

Contracts 1-2-3.(b) 11,850.00 

L. V. Tramways Co...(c) 1,640.00 

Consulting Earnings- 1,980.00 

Report Earnings.... (d) 15,000.00 
A.B.C. Stock Brokers... 10,310.00 
Stocks and Bonds... (e) 2,600.00 

Capital . 16,250.30 


$62,630.30 


The books were kept from June 30, 1915, to June 30, 
1916, by three different bookkeepers, and an audit discloses : 

(a) The account “Brooklyn Terminal Company’’ con¬ 
tains receipts of consulting fees during the first six months 
of 1916. This is a monthly contract involving no expense 
whatever to V. Armstrong. 

(b) “Contracts 1-2-3“ are contracts for reports on the 
engineering possibilities of certain properties. The reports 
have been rendered and the expenses incident thereto have 
been credited to expense and debited to the amount received 
under the contracts. 

(c) “L. V. Tramways Company” represents $2,000 re¬ 
ceived on May I, 1916 (less expenses) on account of a con- 

















PRACTICAL PROBLEMS 


541 


tract according to the terms of which Armstrong is to act 
as consulting engineer for 10 months from May 1 and to 
receive altogether $5,000. .Nothing has been received in 
June and there are to be no further expenses to Armstrong, 
the amount incurred in May representing the fee paid to, 
and the expenses of, an engineer who took Armstrong’s 
place while the latter was incapacitated by illness. 

(d) “Report Earnings” contains fees received under 
contracts for reports on properties, the contracts being 
exactly similar to Contracts 1-2-3. The account represents: 

1. Received on account of contracts on which nothing 

has been done up to June 30, 1916, $8,500. 

2. Balance earned. 

(e) “Stocks and Bonds” represents the credit balance 
of the general investment account; all the securities at one 
time included in this account have been sold. 

(f) The “Expense Account” is composed of: salary— 
Armstrong, $6,000; other salaries, $1,700; rent, $900; ad¬ 
vertising, $700; telegrams, $90; office expenses, $150; other 
expenses, $160. 

(g) Interest represents: debits charged by A. B. C. 
brokers on margin account, $1,300; paid on loans since 
liquidated, $185.30; credits: dividends on stocks still held, 
credited by the brokers, $400. 

(h) From June 30, 1915, to June 30, 1916, there was 
received as dividends on stocks, $1,750; of this amount 
$1,000 was placed to the credit of stocks still held at June 
30, 1916; the balance went to the credit of general invest¬ 
ment account “Stocks and Bonds.” 

Required: 

Journal entries necessary to adjust the books of Vin¬ 
cent Armstrong and make them conform to account¬ 
ing principles. 


542 


PRACTICAL PROBLEMS 


PROBLEM XIII 

To illustrate the necessity of analytical accounting , and 
the accounting meaning of terms “Book Value /’ “Replace¬ 
ment Value“Depreciated Book Value/’ “Providing for 
Reserves by Reappraisement.” (See Chapter XXXII.) 

An analysis of the “Property, Plant, and Equipment” 
of a corporation which began business January i, 1914* 
reveals the following at December 31, 1916: 


Total book value of the account.$1,011,340.00 


Analysis: 

Land—Cost . $50,000.00 

Buildings—Book Value. 575,000.00 


4 factory buildings, built of stone and brick, costing each 
$140,000, erected in 1914, estimated to last 35 years; not 
depreciated; 3 store houses valued at $5,000 each, built of 
wood and tin; erected in 1914, estimated to last 10 years; 
not depreciated. 

Factory Equipment—Cost. 45,000.00 

Boiler Plant, costing $16,000, installed in 1914, not de¬ 
preciated. 

Power Plant, costing $18,500, installed in 1914, estimated 
to last 15 years; not depreciated. 

Belting, Shafting, Pulleys, costing $10,500, installed in 
1914, estimated to last 10 years; not depreciated; no 
charges to account other than cost. 

Machinery—Book Value. 320,000.00 

40 machines as follows; 

20—Universal standard machines, cost, $10,000 each, 
purchased new in 1914, estimated to last 15 years, with 
residual value of $2,000 each. Not depreciated. No 
charges to account other than cost. 

15—Special machines, average cost, $7,500 each, con¬ 
structed in 1914 for the requirements of the factory; 
estimated to last 10 years, with residual value of $500 
each and minimum annual repairs of $100 per machine; 

$500 charged to income in 1915-1916 for repairs on all 
these machines. Not depreciated. These machines are 
subject to being discarded long before their estimated 
life, if better machines are invented for the line of work 








PRACTICAL PROBLEMS 


543 


which they do. Experience has shown that machines of 
this kind become obsolete about every five years, and 
have a residual value of $150. 

5—Second-hand machines, cost, $1,500 each, acquired in 
1915, estimated to last 5 years, with a residual value of 
$60 each. 

Machine Tools—Book Value 12/31/16. 14,000.00 

Original cost, 1914, $18,000; written off the account in 

1915, $2,000. In 1916, $2,000, when issued to factory. In 

1916, purchases amounting to $5,340 were charged to fac¬ 
tory expense. 

Shop Tools—Book Value 12/31/16. 7,340.00 

Issued to factory, credited to Tools account, and charged 
to factory expense: 


1914 .$1,450.00 

1915 . 1,840.20 

1916 . 1,530.40 


Purchased in 1916, and charged to factory expense, 

$2,130.20. 

Sundry items of equipment, amounting to $1,390, charged to 
factory expense when acquired in 1915* _ 

$1,011,340.00 


An independent appraisal has been made at the same 
time as the investigation. The appraisal, as recapitulated 
by the appraisers, shows the following results: 


Buildings—Stone, Brick and Steel 

Buildings—Frame and Tin. 

Boiler Plant. 

Power Plant. 

Belting, Shafting and Pulleys.... 
Machines—Universal Standard... 

Machines—Special. 

Machines—Other . 

Machine Tools. 

Shop Tools. 

Other Equipment. 


Replacement Depreciated 
Value Value 


12/31/16 

12/31/16 

$568,000.00 

$560,000.00 

17,000.00 

12,000.00 

17,500.00 

14,500.00 

19,000.00 

17,000.00 

12,000.00 

9,000.00 

203,000.00 

200,000.00 

114,000.00 

93,000.00 

8,000.00 

5,100.00 

23,000.00 

20,800.00 

9,450.00 

7,000.00 

1,500.00 

950.00 

$992,450.00 

$ 939 , 350.00 



























544 


PRACTICAL PROBLEMS 


The appraisal company recommends that the book value 
of property appraised be increased to the replacement value. 

Inasmuch as some of the work in erecting the buildings 
has been done by the employees of the company; and as, 
further, the basing, erecting, and fitting of the machinery, 
machine tools, and equipment has been done by factory 
hands with material taken from stores (which facts, how¬ 
ever, are not disclosed by the analysis made by the com¬ 
pany), the directors realize that their property and plant is 
probably undervalued. Accordingly, they accept the sug¬ 
gestion of the appraisal company, and decide that the ac¬ 
count “Property, Plant, and Equipment” is to be divided 
into its component parts at December 31, 1916, and stated at 
the replacement value arrived at by the appraisers. 

Reserves for depreciation are to be created on the basis 
of the depreciated values, as of 1915, and as of 1916. 

Required: 

1. Journal entries setting up the component parts of 

the property account on the basis of the com¬ 
pany’s figures adjusted so as to reflect the true 
cost of the individual units. 

2. Journal entries adjusting the books on the basis 

of the replacement value, and providing for re¬ 
serves for depreciation. 


PROBLEM XIV 

From the New York C. P. A. Examination of June, 
/8p8. (See Chapter XXXIII.) 

The balance sheet of a joint-stock company, January 
1, 1897, shows the following state of affairs: 



PRACTICAL PROBLEMS 


545 


Capital Stock. 


Real Estate. 

$50,000.00 

Creditors — Open 

Ac- 

Plant and Machinery... 

85,000.00 

counts. 

_ 16,000.00 

Horses and Wagons... 

15,000.00 

Bills Payable. 

_ 30,000.00 

Patents and Good-Will 

20,500.00 

Profit and Loss 

Ac- 

Inventory. 

49,000.00 

count . 

- 30,500.00 

Accounts Receivable... 

35,000.00 



Cash in Bank. 

22,000.00 


$276,500.00 


$276,500.00 


A year later, January i, 1898, after an audit of the 
books and accounts, the balance sheet stands as follows: 


Capital Stock. 


$200,000.00 

Real Estate. 

$52,000.00 

Creditors — Open 

Ac- 


Plant and Machinery: 


counts. 


17,000.00 

Balance Jan. 


Mortgage. 


25,000.00 

1, 1897.. .$85,000.00 


Profit and Loss 

Ac- 


Less depre- 


count: 



ciation ... 8,500.00 

76,500.00 

Balance last 





year.$30,500.00 

Horses and Wagons: 


Profit this 



Balance Jan. 


year.23,400.00 53,900.00 

1, 1897.. .$15,000.00 





Less depre- 





ciation ... 2,250.00 

12,750.00 




Patents and Good-Will. 

20,500.00 




Inventory. 

65,000.00 




Accounts Receivable... 

33,000.00 




Agency Investments.... 

15,000.00 




Cash in Bank. 

21,150.00 



$295,900.00 

$295,900.00 


From the foregoing it will be seen that for the year 
a net profit of $23,400 has been earned, while the accounts 
receivable are smaller, and the cash balance on hand is less 
than at the beginning of the year, though no dividend has 
in the meantime been paid. Prepare account showing what 
has become of the profits earned. 




































546 


PRACTICAL PROBLEMS 


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Prepare a statement showing amount of ledger assets as of January I, 1910; add to this 
statement the increase of capital stock and the income of the period; deduct from the state¬ 
ment the disbursements of the period, concluding with a balance sheet showing total assets as of 
June 30, 1910. 









































PRACTICAL PROBLEMS 


547 


PROBLEM XVI 

Based upon the systematization of books of account for 
the purpose of facilitating financial statements, and upon 
the closing journal entries necessary to group certain facts 
to be included in said statements. From the New York 
C. P. A. Examination of June, 1912. (See Chapters XXXV 
XXXVII.) 

The following balances are taken from the books of 
the Roberts Manufacturing Company of New York City, 
on December 31, 1910: 

Inventory of Finished Goods (January 1). $3,684.57 

Inventory of Raw Materials (January 1). 11,392.70 

Purchases of Raw Materials. 62,519.85 

Sales . 217,387.42 

Wages . 109,317.88 

Rent .. 19,500.00 

Discounts Received on Purchases. 375.60 

Discounts Allowed on Sales. 186.36 

Power, Light, and Heat. 8,710.64 

Light and Heat for Office. 168.00 

Repairs . 1,090.00 

Packing .*.. 2,017.00 

Factory Expense. 3,270.00 

General Expense. 5,230.00 

Factory Insurance. 1,050.00 

General Insurance. 750.00 

Machinery and Plant. 12,350.00 

Tools . 2,600.00 

Commissions . 7,642.00 

Office Salaries. 9,700.00 

Salesmen’s Salaries. 8,930.00 

Interest on Loans. 440.00 

Loans Payable. 22,000.00 

Discount Lost. 120.00 

Notes Receivable. 130,000.00 

Notes Receivable, Discounted. 8,000.00 

Notes Payable. 19,500.00 

Accounts Receivable. 101,026.00 






























548 


PRACTICAL PROBLEMS 


Accounts Payable. 

Office Furniture. 

Furniture and Fixtures. 

Cash on Hand. 

Cash in Banks. 

Returned Sales. 

Capital Stock. 

Reserve for Depreciations. 

Reserve for Bad Debts. 

Freight and Cartage Inward... 

Stable Expenses. 

Horses, Wagons and Harnesses 

Postage and Expressage. 

Superintendence. 

Taxes. 

Good-Will. 

Stationery and Printing. 

Advertising. 

Surplus (1909). 


30,020.00 

1,100.00 

1,950.00 

1,825.00 

26,467.00 

276.00 

200,000.00 

3,236.98 

5,727.00 

727.00 

2,750.00 

8,500.00 

1,250.00 

3,500.00 

250.00 

10,000.00 

1,080.00 

8,630.00 

63,75300 


1. Prepare from the above a trial balance arranged in 
systematic order, so as to facilitate the preparation of fi¬ 
nancial or business statements. 

2. Draft journal entries for closing the books. 

3. Certify your results by a balance sheet. Support 
the surplus shown by the balance sheet by a statement of 
income and profit and loss. 

The following items are to be taken into consideration: 


Inventories: 

Raw Materials.:. $16,250.00 

Finished Goods. 9,386.00 

Tools . 2,000.00 

Office Furniture. 1,000.00 

Furniture and Fixtures. 1,500.00 

Stationery and Printing. 300.00 


Allow for depreciations: on machinery, 5% ; on horses, 
wagons and harnesses, 10%. 

Reserve for bad debts: 3% on accounts receivable only. 



























PRACTICAL PROBLEMS 


549 


The item for rent, $19,500, is to be apportioned as fol¬ 
lows: 53% f° r factory, 22% for salesrooms, and 25% for 
office. 

The item of superintendence, $3,500, is to be divided, 
3/5 to factory and 2/5 to general expense. 


PROBLEM XVII 

Based on the application of double-entry principles to the 
establishment of financial statements — introducing the 
technique of journalizing, and the theories which underlie 
the various forms assumed by the said statements. (See 
Part V.) 

Armstrong & Campbell accept the offer made to them 
by H. Dover on July 1, by which he is to invest $25,000 
in the business, becoming a special partner, and sharing 
to the extent of one-fifth in their profits. On July 2 
Dover agrees to exert all his business ability towards the 
welfare of the concern. He pays to the business an addi¬ 
tional $5,000 in cash; this is to be treated as additional 
capital invested by J. Armstrong and A. Campbell equally 
and is in the light of a payment by Dover to the old partners 
personally for their services in acquiring the good-will which 
the business possesses. The value of good-will has been 
agreed to be $6,000. 

The new articles of copartnership provide that the part¬ 
ners shall share in the profits to the extent of, Armstrong, 
two-fifths; Campbell, two-fifths; Dover, one-fifth. No in¬ 
terest is to be credited on capital invested. 

A new bookkeeper has been engaged by the firm, and 
at July 31, 1916, he presents the following trial balance: 



55o 


PRACTICAL PROBLEMS 


Trial Balance, July 31, 1916 


Debits 

Cash .$45,961.90 

Land and Building. 6,000.00 

Furniture and Fixtures. 975-00 
Horse, Wagon and Har¬ 
ness . 3,150.00 

Good-Will. 6,000.00 

Merchandise Inventory.. 59,843.04 
Freight Inward on Pur¬ 
chases Sold. 662.80 

Freight Inward on Pur¬ 
chases Unsold. 95.90 

Trade Discount—Cus¬ 
tomers . 1,614.60 

Allowances on Defective 

Sales. 307.20 

Freight and Cartage, 

Outward. 101.50 

Heat and Light. 6.40 

Stable Expenses. 112.15 

Salaries—Clerks . 160.00 

—Partners. 100.00 

—Salesmen. 300.00 

Sundry Expense. 65.00 

Accounts Receivable_20,238.67 

Notes Receivable. 8,200.00 

Foreign Exchange. 12.30 

Legal Expense. 60.00 

Purchases—Merchandise 25,350.30 
Sales Returned. 2,647.87 


$181,964.63 


Credits 

Returned Purchases... .. $1,960.30 

Sales. 72,105.00 

Interest on Bank Bal¬ 
ance . 22.10 

Commission — Consign¬ 
ment . 345-iS 

Trade Discount—Credi¬ 
tors . 1,085.50 

Allowances on Purchases 241.26 
1st Mortgage, Payable 

1918. 2,500.00 

Notes Payable. 11,400.00 

Accounts Payable. 10,640.21 

J. Armstrong, Capital... 29,265.30 
A. Campbell, “ ... 27,399.78 
H. Dover, “ ... 25,000.00 


$181,964.63 


The following facts are submitted: 

Inventory, July 31, 1916: merchandise, $28,423.34. 
Notes receivable; notes outstanding July 1, 1916, 
collected, $9,800; new notes received, $6,000. 







































PRACTICAL PROBLEMS 


551 

Notes payable: notes outstanding July 1, 1916, paid, 
$26,600; new notes given, $8,000. 

Consignments—all sold, all sales collected; allowances : 
No. t, $4.50; No. 2, $6.20; freight on sales: No. 1, 
$30.10; No. 2, $45.02; No. 3, $2.25. Balance due 
to consignors, remitted. 

Stable expense—50% applicable to freight and cartage 
inward; the balance applies to goods sold. 

From the foregoing, and from the facts in Problem IV, 
prepare: 

1. The journal entries incident to the admission of 

the new partner, and to the closing of the books. 

2. Statement of income and profit and loss. 

3. General balance sheet. 

4. Trading and profit and loss account subdivided into 

sections corresponding to the main groups of 
facts found in the “Statement of Income and 
Profit and Loss/’ 

5. Account sales to consignor No. 1 from March to 

July, 1916, both inclusive. 


PROBLEM XVIII 

From the New York C. P. A. Examination of February, 
ipio. (See Part V.) 

The directors of a manufacturing company, before the 
closing and auditing of the books for the half year ending 
December 31, declared out of the net earnings of the com¬ 
pany, a dividend for the half year of 4% on the preferred 
stock of $100,000 and 3% on the common stock of $100,000. 



552 


PRACTICAL PROBLEMS 


There has been brought forward from the last half year an 
undivided balance of profit of $4,000 and after the audit 
of the books the trial balance is found to be as fol¬ 
lows: 


Trial Balance, December 31 


Real Estate and Build- 


Preferred Stock.... 


ing. 

$32,500.00 

Common Stock. 

... 100,000.00 

Plant and Machinery... 

40,000.00 

Sales. 

... 219,175.00 

Patents and Good-Will. 

80,000.00 

Notes Payable. 

... 26,000.00 

Inventory, July I. 

29,000.00 

Accounts Payable... 


Purchases . 

82,500.00 



Labor . 

88,000.00 



Coal. 

6,000.00 



Salaries—General . 

11,000.00 



Salaries—Management .. 

5,000.00 



Insurance . 

875.00 



Allowances. 

6,250.00 



Freight. 

1,500.00 



Discount and Interest... 

750.00 



Cash in Bank. 

8,000.00 



Investments. 

15,500.00 



Miscellaneous Expense.. 

4,300.00 



Book Debts. 

42,000.00 



Preferred Stock in 




Treasury. 

5,000.00 



Repairs. 

1,000.00 



$ 459 , 175-00 


$ 459 , 175-00 


Stock on hand, $26,500. From the above prepare 
profit and loss and income statement and balance sheet, 
giving effect in accounts to depreciation at the rate of 
yy 2 % a year on plant and machinery, and making an 
allowance of 5% on the book debts to provide for bad 
debts; also create a liability in the balance sheet for 
dividend as stated. 





























PRACTICAL PROBLEMS 


553 


PROBLEM XIX 

Introducing one of the methods of merging corporations. 
From the New York C. P. A. Examination of January, 
ipi2. (See Part V.) 

The Burnwell Gas Company is incorporated on 
January i, 1910, with an authorized capital of $300,000 
(2/3 preferred stock and 1/3 common),* to acquire and 
conduct the business of the Safety Gas Company, whose 
general balance sheet shows the following on December 31, 
1909: 


Buildings, Machinery 


Notes Payable. 

.. . $10,000.00 

and Equipment.$100,000.00 

Accounts Payable... 

... 52,000.00 

Mains, Conduits, Meters 


Capital Stock. 


and Connections. 

70,000.00 

Surplus. 


Franchises, Rights, 




Privileges, etc. 

50,000.00 



Materials and Supplies. 

15,000.00 



Tools and Emergency 




Equipment. 

10,000.00 



Cash . 

11,800.00 



Accounts Receivable... 

35,200.00 

% 


$292,000.00 


$292,000.00 


On January 15, 1910, all the preferred and common 
stock of the Burnwell Gas Company was issued to the 
20 stockholders of the Safety Gas Company, in exchange 
for their holdings of stock of the latter company, in the 
proportion of one share of preferred and one share of 
common for each share of stock exchanged. 

At a meeting of the board of directors of the Safety 

•The original problem reads: “All the shares being of the par value of $100.” 
As this is unworkable from the point of view of the issue of stock, the problem 
has been changed to read as above. The error is evidently due to a misprint. 




















554 


PRACTICAL PROBLEMS 


Gas Company, held January 20, 1910, it was resolved to 
carry out the provisions of a plan of merger in accordance 
with which the Safety Gas Company was to transfer its 
assets and liabilities to the Burnwell Gas Company and 
surrender its charter. A certificate of merger was issued 
at the close of the meeting. 

At a meeting held January 31, 1910, the board of di¬ 
rectors of the Burnwell Gas Company resolved to open ac¬ 
counts on the general books of the company, with the in¬ 
dividual assets and liabilities taken over and assumed, at 
the figures shown by the balance sheet of the Safety Gas 
Company at December 31, 1909, with the following excep¬ 
tions: (a) franchises, etc., to be raised to $70,000; (b) sur¬ 
plus not to be carried. 

As to the January operating transactions, they were 
recorded in special books, in order that they might be em¬ 
bodied at the proper time in the books of the Burnwell Gas 
Company. 

Prepare: 

1. Chronological journal entries reflecting on the books 

of the Burnwell Gas Company the different 
stages of the merger. 

2. A journal entry closing the books of the Safety 

Gas Company. 


PROBLEM XX 

To introduce the subject of the holding company, and to 
illustrate the theory of consolidated balance sheets . (See 
Chapter XXXVIII.) 

The Great Eastern Securities Company is organized un¬ 
der the laws of the State of New Jersey, “to purchase, hold, 



PRACTICAL PROBLEMS 


555 

sell, assign, transfer, pledge, or otherwise dispose of the 
shares of the capital stock of, or any bond, securities, or 
other evidences of indebtedness created by, any other cor¬ 
poration or corporations of this or any state.” 

The company has an outstanding capital stock of 
$6,000,000, represented by 60,000 shares of common 
stock, which has all been subscribed and 50% paid in. 

In July, 1916, the Up-State Electric Lighting Company, 
doing business in the State of New York and capitalized at 
$1,000,000, of which $200,000 is preferred stock, and 
having an outstanding issue of $500,000 of 6% bonds due 
August 15, 1916, finds itself so discredited, owing to bad 
management and losses due to floods, that it cannot hope 
to provide funds to retire the issue of bonds at maturity. 
In the course of the life of the bonds, the Up-State Com¬ 
pany has created an adequate reserve for its bonded in¬ 
debtedness, which now equals the liability for bonds, but 
has not been funded. 

The Up-State Company has a surplus of $175,000, but 
among its assets there is an investment of $250,000, rep¬ 
resenting cost, amortized to par, of 6% sewer bonds of the 
City of Rochester and Town of Gates. These bonds were 
defaulted as to principal in 1914, the City of Rochester 
having disclaimed liability thereunder. 

The Great Eastern Company, being cognizant of the 
financial distress of the Up-State Company, offers to pur¬ 
chase its whole capital stock outstanding, paying $98 for 
the preferred and $95 for the common. It also offers to 
advance to the Up-State Company $500,000 to retire out¬ 
standing bonds at maturity, and to purchase at $94 the 
whole of a new issue of bonds amounting to $500,000, due 
1930, to be made by the Up-State Company, and to be 
secured by the same mortgage now covering the issue to 
be retired. 


556 


PRACTICAL PROBLEMS 


The Great Eastern Company further proposes to ac¬ 
quire, at 50% of their face value, the sewer bonds held 
by the Up-State Company. The purchaser has informa¬ 
tion leading to the belief that 50 or 60% of the face value 
of the securities will eventually be paid to the bond¬ 
holders. 

The negotiations go through, and all these transac¬ 
tions take place during the month of August. The whole 
capital stock of the Great Eastern Company is issued in 
August, 

The balance sheet of the Up-State Electric Company 
at the time of the acquisition of that company’s stock by 
the Great Eastern Securities Company was as follows: 


Land and Buildings.. .$550,750.00 
Machinery, Service 

Lines and Mains.... 1,079,380.00 

Tools and Supplies_ 124,350.00 

Cash. 30,150.00 

Investments . 250,000.00 

Accounts Receivable... 182,750.00 
Deferred Charges to 

Income . 7,350.00 

Capital Stock: 

Preferred .$200,000.00 

Common . 800,000.00 

6% Bonds, 1916. 500,000.00 

Accounts Payable. 49,730.00 

Surplus. 175,000.00 

Reserve for Redemption 
of Bonds. 500,000.00 

$2,224,730.00 

$2,224,730.00 


Required: 

1. The journal entries expressing the above transac¬ 

tions on the books of the Great Eastern Securi¬ 
ties Company. 

2. The balance sheet of the Great Eastern Securities 

Company at August 31, 1916. 

3. The balance sheet of the Up-State Electric Light¬ 

ing Company at August 31, 1916. 

4. The consolidated balance sheet of the two com¬ 

panies at August 31, 1916. 



















PRACTICAL PROBLEMS 


557 


PROBLEM XXI 

Illustrating the technique of the consolidated balance 
sheet . (See Chapter XXXVIII.) 

The F. L. Company owns the stock of two operating 
companies; the investment stands on its books at $500,000, 
for which the holding company issued its own stock in the 
amount of $200,000 of preferred and $200,000 of common, 
and $100,000 of 5% gold bonds. The authorized capital 
stock of the holding company is $500,000, $300,000 being 
preferred; the authorized bond issue is $100,000; the capital 
stock is all issued, full-paid, and non-assessable. The bal¬ 
ance sheet of the operating companies, at the time the hold¬ 
ing company purchased their stock, was as follows: 


Assets 

Co. X Co. Y 

Land, Buildings and Realty Fixtures*. $50,000.00 $74,000.00 

Machinery and Machine Tools. 45,000.00 39,000.00 

Plant Movable Equipment. 10,000.00 7,000.00 

Shop and Hand Tools. 6,000.00 3,000.00 

Furniture and Personalty Fixtures. 4,900.00 5,000.00 

Office Equipment. 1,050.00 1,740.00 

Goods in Progress. 15,000.00 17,300.00 

Finished Goods. 7,5oo.oo 11,800.00 

Raw Materials. 17,000.00 21,850.00 

Sundry Factory Supplies. 3,500.00 6,650.00 

Investments: 

Bonds, Company Y. 50,000.00 

Bonds, Other Industrial Companies. 10,000.00 

Accounts Receivable. 34,850.00 31,580.00 

Cash . 3,94i 00 30,500.00 

Demand Notes Company. 5,000.00 

Accrued Interest: 

Bonds, Company Y. 1,500.00 

Bonds, Other Industrial Companies. 300.00 

Advances—Company X. 10,000.00 


$265,541.00 $259,420.00 


depreciation charged to cost of goods, deducted from the asset in the 
amount of $9*500. 



























558 


PRACTICAL PROBLEMS 


Liabilities 



Co. X 

Co. Y 

Capital Stock: 

Preferred . 

.$100,000.00 


Common . 

. 100,000.00 

$50,000.00 

Bonds: 

Principal . 


150,000.00 

Interest . 


4,500.00 

Notes Payable. 

. 2,000.00 

15,000.00 

Advances Payable. 

. 10,000.00 


Accounts Payable. 


9 , 345-00 

Surplus : 

Reserved: 

For Depreciation of Physical Assets 

(not 


charged to cost of goods). 


11,300.00 

For Redemption of Bonds. 


7,500.00 

For Doubtful Accounts Receivable. 

. 1,035.00 

637.00 

Available for Dividends. 


11,138.00 


$265,541.00 $259,420.00 


Required: 

The consolidated balance sheet of the three companies, 
established in accordance with the request of the 
board of directors of the F. L. Company for exact 
information as to the properties which the latter 
company controls. 


PROBLEM XXII 

Introducing a discussion of the effect of the rulings of 
the Interstate Commerce Commission upon generally ac¬ 
cepted accounting theories and methods. (See Part V.) 

From the following trial balance after closing and the 
footnotes attached, prepare the balance sheet of the Blank 
Railroad Company as at December 31, 1916, in accordance 
with the rulings of the Interstate Commerce Commission, 
effective July I, 1914. 




















PRACTICAL PROBLEMS 


559 


Trial Balance 


(1) Investment in Road 

and Equipment. .$17,900,900 

(2) Miscellaneous 

Physical Property 684,750 

(3) Expenditures on 

Leased Railway 
Property. 360,000 

(4) Sinking Funds: 

(a) For Redemp- 

t i o n of 
Equipment 
Certificate.. 465,900 

(b) ForRedemp- 

t i o n of 
Mortgage 
Bonds .... 550,000 

Investments: 

(5) (a) Investments 

in Affiliated 

Companies. 2,355,000 

(6) (b) Other In¬ 


vestments.. 396,5°° 

(7) Cash. 1,943,900 

(8) Deposits and Loans 3,968,600 

(9) Accounts Receiv¬ 

able . 694,000 

(10) Materials and Sup¬ 

plies . 3i5,ooo 

(11) Interest and Rents 

Receivable . 360,150 

Working Funds in 
Handsof General 
and Special 

Agents. 18,410 

Rentals Paid in 

Advance . M5 0 

Insurance Paid in 
Advance. 5,680 

(12) Suspense Account 284,471 

Discounts on Cap¬ 
ital Stock (net). 18,560 


Capital Stock: 

(a) Preferred .. 

(b) Common ... 

(14) Funded Debt. 

(15) Accounts Payable. 
Loans Payable.... 
Unmatured Divi¬ 
dends Declared.. 

(16) Accrued Liabilities 

Premiums on Fund¬ 
ed Debt. 

Premium on Cap¬ 
ital Stock. 

(17) Land Grants. 

(18) Reserves . 

Profit and Loss.... 


$5,000,000 

10,000,000 

7 , 348,900 

798,190 

500,000 

2,300,000 

23,050 

41,030 

29,645 

300,000 

3 , 313,190 

3,008,072 



















56° 


PRACTICAL PROBLEMS 


Trial Balance— Continued 


Discounts on Fund- 


ed Debt (net) ... 39,™6 


(13) Securities Issued— 


Unsold. 2,300,000 


$32,662,077 

$32,662,077 


(1) Credits for abandoned property subsequent to June, 1916, $75,000. 

(2) As follows: mines, $150,000; hotels and restaurants, $75,000; tim¬ 

ber lands, $160,000; land and buildings not used for operations, 
$250,000; materials leased to others, $49,750. 

(3) Expenditures represent improvements. 

(4) As follows: (a) cash, $155,000; securities of other companies, 

book value, $310,900; (b) cash, $50,000; securities issued by the 
company (par value), $500,000. 

(5) Stocks, $1,550,000; bonds, $600,000; notes, $75,000; advances, 

$130,000. 

(6) Stocks, $250,000; bonds, $100,000; advances, $36,000; miscellaneous, 

$10,500. 

(7) As follows: deposits subject to check, $1,850,000; sight drafts and 

sight bills of exchange credited to remitters, $75,000; cash in 
offices, $18,900. 

(8) As follows: demand loans fully secured, $60,000; demand de¬ 

posits, banks, $159,000; time drafts receivable, $45,800; time 
deposits, banks, $800,000; deposits for dividends, $2,300,000; 
guarantee deposits (contracts for construction), $500,000; de¬ 
posits for injuries, $49,800; unsecured loans and bills, maturity 
less than one year, $54,000. 

(9) As follows: traffic and car service balances, $609,000; due from 

conductors and agents, etc., $39,800; collectible from U. S. 
Government (mail), $19,600; individuals and companies, $25,600. 

(10) As follows: materials in stores, cost, $340,000; depreciation, 

$25,000. 

(11) As follows: interest, $210,000; rents, $50,150; dividends declared 

on stocks owned, $100,000. 

(12) Contains: remainder of value of property abandoned prior to 

June, 1916, $201,340; property abandoned subsequent to June, 
1916, $75,000; freight claims paid, not investigated so far as 
other carriers are concerned, $3,101; estimated depreciation on 
equipment leased, $5,030. 













PRACTICAL PROBLEMS 


561 

(13) As follows: bonds, $1,000,000, of which $500,000 are pledged to 

secure loans; stocks issued and reacquired by purchase, not 
pledged, $300,000. Not sold, but signed and ready for sale, 
$1,000,000. 

(14) As follows: equipment obligations, $1,203,900; mortgage bonds, 

$5,600,000; miscellaneous, $395,000; long term, non-negotiable 
notes to affiliated companies, $150,000. 

(15) As follows: traffic and car service balances, $701,450; audited 

vouchers unpaid, $42,830; wages payable, $50,200; miscellaneous, 
$3,710. 

(16) As follows: interest accrued, $11,300; rents accrued, $4,650; taxes 

accrued, $7,100. 

(17) Original value of land granted in aid of construction. 

(18) Unapplied balance of current charges to equalize revenue. Main¬ 

tenance of road and equipment, $20,640; injuries, $49,800. 
Charges to operating expense for depreciation of road, $1,001,- 
500; for equipment, $500,000; miscellaneous physical property, 
$55,000. For redemption of mortgage bonds, $550,000; for re¬ 
demption of equipment certificate, $465,900; for addition to 
property, $350,000; for funded debt now retired, $260,000; 
miscellaneous reserves not specifically invested, $60,350. 


PROBLEM XXIII 

To illustrate the theory of the statement of affairs in 
connection with sole proprietorship and copartnership and 
the meaning of the deficiency account. (See Chap¬ 
ter XXXIX.) 

On October 1, 1916, John Doe finds himself insolvent. 
His creditors may agree to allow him to settle his affairs 
under the provision of the state insolvency laws, as he 
wishes to do, but they withhold their decision until sub¬ 
mission to them of a statement of affairs. John Doe’s books 
show: 



562 


PRACTICAL PROBLEMS 


Debits 

Cash. $3,000.00 

Land and Building. 40,000.00 

Furniture and Fixtures.. 5,000.00 

Delivery Equipment. 3,000.00 

Merchandise Inventory 

Sept. 30. 32 000 os 

Accounts Receivable.... 61,130.00 
Notes Receivable (no in¬ 
terest) . 8,000.00 

Insurance on Building, 

Unexpired. 50.00 

Advertising Unexpired.. 100.00 

Salaries . 2,620.00 

Expenses. 4,155.40 


$ 159,05540 


Credits 


1st Mortgage 5%, due 

Dec. 31, 1916.$26,000.00 

Notes Payable (no in¬ 
terest) . 23,000.00 

Accounts Payable. 71,600.00 

Taxes Due. 130.00 

Salaries and Wages Due 315.00 

Merchandise. 5,140.25 

Interest Accrued on 

Mortgage. 260.00 

Capital . 32,610.15 


$ 159,05540 


The personal debts of John Doe amount to $625, rep¬ 
resented by the following: 


Due to Butcher. $75.00 

“ “ Grocer. 89.40 

K. T. Realty Co. for rent. 350.00 

“ Constant & Sinclair, Dry-Goods. 110.60 


$625.00 


His personal property is as follows: 


One Horse, valued at. $250.00 

One Surrey and Harness, valued at. 350.00 


25 shares of Golden Horn Mining Co., par, $50... 1,250.00 
Cash in Southern Bank. ctt m 


$2,361.30 


In due course of time the following appraisals are ob¬ 
tained : 







































PRACTICAL PROBLEMS 


563 

Land and building, $42,000; furniture and fixtures, 
$3,000; delivery equipment, $2,100; merchandise in- 
ventory, $25,000. 

The accounts receivable are found to be: 

Good, $29,600; doubtful, $15,650; uncollectable, 
$15,880. It is estimated that the doubtful accounts 
may realize $4,500; the notes receivable will prob¬ 
ably be met at maturity; advertising contracts are 
lost; insurance refund will approximate $17.10. 

As to personal property: 

The delivery equipment will realize $400; the market 
value of the Golden Horn stock is $40 per share. 

Required: 

A statement of affairs and a deficiency account. 


PROBLEM XXIV 

From the Nezv York C. P. A. Examination of January, 
1906. (See Chapter XXXIX.) 

The Parker Construction Company is unable to meet 
its obligations and is forced into liquidation. At the 
time the receiver takes charge of its affairs, the following 
trial balance is prepared from the company’s books: 


Cash. $500.00 

Land and Buildings. 10,000.00 

Mortgage on Land and Buildings. $8,000.00 

Plant and Equipment... 20,000.00 

Creditors. 59,400.00 

Completed Contract Accounts (Losses). 18,000.00 

Capital . 50,000.00 










PRACTICAL PROBLEMS 


5 6 4 


Uncompleted Contract Accounts (Outlay). 30,000.00 

Debtors’ Accounts for Completed Contracts.... 6,000.00 
Securities Acquired in Settlements. 15,000.00 

Inventory of Materials. 2,000.00 

Expenses . 6,500.00 

Profit and Loss (Deficiency). 9,400.00 


$117,400.00 $117,400.00 


The sureties on the unfinished contracts estimate that 
a further outlay of $20,000 will be required to complete 
the work and realize the contract price of $40,000, and 
their offer to take over the materials on hand for $1,500, 
as part of said cost, is accepted by the receiver. Of the 
securities acquired, $5,000 is pledged to secure $11,000 due 
creditors, and $10,000 is pledged to secure $9,000 due credi¬ 
tors. The company owes for taxes on real estate, $100, 
and for salaries and wages of employees, $1,200, which 
sums do not appear on the books. The company has dis¬ 
counted customers’ notes for $3,000, of which subsequent 
advices indicate that $1,000 will be dishonored, and a debtor 
owing $1,500 on unsecured account has failed and disap¬ 
peared. It is estimated that the amount realized on land 
and buildings will be sufficient to satisfy the mortgage only, 
and that plant and equipment will realize only 60% of the 
book value. 

Prepare a statement of affairs and deficiency account. 


PROBLEM XXV 

From the New York C. P. A. Examination. (See Chap¬ 
ter XXXIX.) 

The Republican Asphalt Contracting Company is forced 
into liquidation; and the receiver, when taking possession, 
finds the books of account to show: 
















PRACTICAL PROBLEMS 


565 


Liabilities 

Bills Payable. 

Creditors’ Open Accounts. 

Mortgage on Real Estate and Improvements... 
Mortgage on Contracting Equipment. 


Capital Stock Subscribed .$100,000.00 

Less Not Paid Up. 2,500.00 


$18,000.00 

75,500.00 

17,500.00 

7,000.00 

97,500.00 $215,500.00 


Assets 


Cash in Bank and Office. $700.00 

Bills Receivable. 4,300.00 

Debtors’ Accounts. 8,200.00 

Bonds and Warrants. 23,000.00 

Real Estate and Improvements. 35,000.00 

Manufacturing Plant. 24,000.00 

Contracting Equipment. 14,000.00 

Uncompleted Contracts (Cost). 41,000.00 

Inventory of Materials and Supplies. 3,500.00 $153,700.00 


The bondsmen on the unfinished contract estimate that 
an expenditure of $25,000 will complete the uncompleted 
contract and realize the contract price of $60,000, and their 
offer of $2,750 for the inventory of material and supplies 
as part of said expenditure, is accepted by the receiver. The 
company owes for personal taxes and adjustment of em¬ 
ployer’s liability premiums, $175 and $100, respectively, and 
unpaid labor accounts amounting to $1,700, which amounts 
do not show on the books of account. 

The bills receivable, amounting to $4,300, are pledged 
as collateral for $3,500 due creditors, and $20,000 of the 
bonds and warrants have been given as security for 
$33,000 due creditors. $1,000 of the bills receivable is 
subsequently dishonored. 

The receiver finds that $1,100 of the debtors’ accounts 
is collectable. The sale of real estate and improvements 
(book value of $35,000) realizes $32,500; manufacturing 



















566 


PRACTICAL PROBLEMS 


plant, 40% of the book value; contracting equipment, 35% 
of book value. 

Prepare a statement of affairs and deficiency account. 


PROBLEM XXVI 

From the New York C. P. A. Examination of June, 
1907. (See Chapter XL.) 

The Fox and Dix Company, a close corporation, became 
embarrassed through the failure of a friendly company to 
whom they had given their accommodation paper, and a 
trustee was appointed February 1, 1906, to take charge of 
their affairs for the benefit of the creditors. 

The condition of the estate, when the trustee took charge, 
was as follows: 


Liabilities 

Mortgage on Real Estate, maturing February 1, 1907 .$15,000.00 

Interest, due February 1, 1906, six months, at 5 % . 375-00 

Taxes Due. 210.00 

Book Accounts Payable. 3,900.00 

Bills Payable (including accommodation paper, $56,000) . 57,400.00 

Capital Stock. 40,000.00 

Surplus, per profit and loss account. 3,987.00 


$120,872.00 


Assets 

Cash on Hand and in Bank. 

Merchandise (stock of goods). 

Book Debts (including accommodation account, $56,000).... 

Bills Receivable. 

Real Estate. 


$650.00 

25,310.00 

60,800.00 

4,112.00 

30,000.00 


$120,872.00 



















PRACTICAL PROBLEMS 567 

In order to complete contracts and so realize to the best 
advantage on the goods in stock, the trustee purchased mer¬ 
chandise to the amount of $50,000, and during the year 
collected $100,002 cash from sales. 

The accommodation account was settled for 60%. The 
other book debts realized $4,100, and the bills receivable, 
$3,600. Balance, lost. 

The accommodation paper was settled by paying $40,- 
000 cash and renewing $16,000, entailing legal fees, interest, 
and petty expenses of $2,200. 

The other bills payable, the accounts payable, taxes and 
interest on mortgage for eighteen months* were paid in 
course of settlement, and the principal of the mortgage was 
paid off at maturity. 

The running expenses were as follows: clerk hire, 
$1,500; office expenses, $1,000; allowances to officers, 
$3,000; trustee’s commissions, $3,000. 

On February 1, 1907, the trustee surrendered charge 
of the company’s offices and paid over the cash balances in 
his hands. On said date there were also uncollected 
book debts amounting to $2,000, and merchandise stock, 
$8,000. 

Prepare a realization and liquidation account, a trustee’s 
cash account, and a balance sheet of the estate at termina¬ 
tion of trust. 


PROBLEM XXVII 

From the New York C. P. A. Examination of Jane, 
Ipi2. (See Chapter XL.) 

The following is the trial balance of the Rawdeal Com- 



5 68 


PRACTICAL PROBLEMS 


pany, June i, 1911, on which clay the directors of the com¬ 
pany resolve that the secretary of the company be author¬ 
ized to call a meeting of the stockholders, to vote on the 
immediate dissolution of the company: 


Land.$15,000.00 

Building and Realty Fix¬ 
tures . 40,000.00 

Machinery and Machine 

Tools. 35,000.00 

Shop and Hand Tools 

(in store). 5,000.00 

Furniture and Personalty 

Fixtures . 9,700.00 

Raw Materials and 

Freight thereon. 10,350.00 

Accounts Receivable.... 23,400.00 
Cash in Bank and in 
Offices. 11,320.00 


Bond Secured by Mort¬ 
gage*—6%.$26,000.00 

Interest Accrued on 
Bond Secured by Mort¬ 
gage . 312.00 

Accounts Payable.21,700.00 

Reserve for Depreciation 

of Building. 5,300.00 

Reserve for Depreciation 

of Machinery. 8,000.00 

Reserve for Depreciation 
of Furniture and Fix¬ 
tures . 5,100.00 

Surplus. 23,358.00 

Capital Stock, Author¬ 
ized, Issued and Out¬ 
standing .60,000.00 


$ 149 , 770.00 


$149,770.00 


*Building and realty fixtures pledged thereunder. 


The stockholders’ meeting was held on July 1, 1911, 
and the dissolution took place. The company sold the build¬ 
ing and its equipment to the mortgagee for $34,000 as of 
August 15, 1911. On September i, 1911, the cash book 
showed: 

Debits: 

Building and realty fixtures, $7,454; machinery, 
$25,340; shop and hand tools, $2,100; furniture and 
fixtures, $3,700; raw materials, $7,950; accounts re¬ 
ceivable, $23,130. 


























PRACTICAL PROBLEMS 


569 


Credits: 

Accounts payable, $21,700; expenses, $1,530.20. 
Prepare: 

1. The journal entries affecting the dissolution of the 

company. 

2 . A statement of realization and liquidation that will 

show the per cent received hy the stockholders 
on their holdings. 


PROBLEM XXVIII 

Based upon the same principles as the preceding prob¬ 
lem. From the New York C. P. A. Examination of Janu - 
ary, 1913. (See Chapter XL.) 

James Stetson is appointed trustee of the manufactur¬ 
ing business of John Brightlawn, for the purpose of 
rehabilitation. On taking charge he finds that the avail¬ 
able assets are: cash in bank, $356; accounts receivable: 
(a) good, $3,712; (b) probably uncollectable, $350. The 
working and trading assets consist of raw materials, 
$17,258; sundry manufacturing supplies, $700; finished 
goods, $8,000; goods in process, $30,945.70. Other assets 
comprise: machinery and machine tools, $41,000; shop and 
hand tools, $1,300; deferred debits to manufacturing, 
$530. The liabilities are as follows: creditors' accounts, 
$39,700; wages accrued: productive, $500; unskilled, $230. 

The transactions under the trusteeship are as follows; 
Loaned by creditors for immediate needs, $7,000. Pur¬ 
chased on book accounts: raw materials, $8,300; sundry 
manufacturing supplies, $9,500. Factory expense: paid in 
cash, $1,300; incurred as a liability to creditors and sub¬ 
sequently liquidated, $2,100. The doubtful accounts re¬ 
ceivable proved worthless. Cash paid for: productive labor, 



570 


PRACTICAL PROBLEMS 


$16,000; unskilled labor, $2,500; general expense, $8,000; 
additional shop tools, $609; freight inward, on raw ma¬ 
terials manufactured and sold, $60. Interest allowed to 
creditors on their accounts amounted to $143.10. The 
trustee advanced $4,300 to John Brightlawn on account of 
expected profits; the sales of finished goods amounted to 
$91,000. 

At the close of the trusteeship, the trustee’s books show 
the working and trading assets to be: finished goods, 
$11,000; goods in process, $10,450; raw materials, 
$1,945.70; manufacturing supplies, $395.25. There is be¬ 
sides an amount of $750.10 representing factory expenses 
unapplied. The creditors’ accounts show a balance of 
$1,650.30, while the uncollected accounts receivable 
amount to $2,975.36. The shop and hand tools amount to 
$1,609. 

Prepare an account which, while respecting the fidu¬ 
ciary character of the relations of the trustee and of the 
proprietor of the business, will reflect logically and clearly 
the result of J. Stetson’s administration. 


PROBLEM XXIX 

To introduce the legal requirements of the bankruptcy 
schedules. (See Chapter XXXIX.) 

On July 1, 1916, John Doe petitions the Court, asking 
to be adjudged a voluntary bankrupt. The facts embodied 
in the required schedules which he presents to the Court 
are as follows: 

Statement showing trial balance of the books of John 
Doe at June 30, 1916, and the estimated worth of assets; 



PRACTICAL PROBLEMS 


571 


Assets 


Cash on Hand. 

Cash in Banks. 

Accounts Receivable. 

Land and Building. 

Machinery and Machine Tools. 

Shop Tools. 

Notes Receivable. 

Furniture and Fixtures. 

Patents. 

Stationery and Printing (books of account and 

records in use). 

Transportation Equipment. 

Materials and Supplies. 

Goods in Process (materials only). 

Finished Goods. 

Wages . 

Selling Expense. 

Factory Overhead. 

General Administration Expense. 


Trial 

Estimated 

Balance 

Worth 

$1,000.00 

$1,000.00 

5,830.40 

5,830.40 

42,540.20 

35,000.00 

60,000.00 

50,000.00 

31,500.00 

15,000.00 

3,700.00 

1,100.00 

5,000.00 

5,000.00 

4,000.00 

1,900.00 

10,000.00 

3,000.00 

380.00 

380.00 

2,350.00 

1,500.00 

17,000.00 

9,000.00 

39,700.00 

22,000.00 

21,500.00 

20,000.00 

11,150.40 


3,100.00 


2,150.00 


7,930.00 


$268,831.00 

$170,710.40 


Liabilities 

Trial 

Balance 

Capital and Profits. $60,500.00 

Mortgage Payable, December, 1916. 40,000.00 

Accounts Payable. 137,975.60 

Wages Payable. 3,150.40 

State Taxes Due. 205.00 

Notes Payable. 19,000.00 

Reserve for Depreciation of Machinery and 

Tools . 5,000.00 

Reserve for Depreciation of Building. 3,000.00 


$268,831.00 


Inventory of the personal property and debts of John 
Doe at June 3°> 1916: 





































572 


PRACTICAL PROBLEMS 


Stock—25 shares of Mex¬ 
ican Mines — market 

value.$1,000.00 

(Par value, $50.) 

Household Furniture: 

Kitchen Utensils, esti¬ 


mated worth. 150.00 

Other Furniture, esti¬ 
mated worth. 1,500.00 

Library, estimated worth. 400.00 


Wearing Apparel—includ¬ 
ing S. N. G. uniforms 


and equipment. 580.00 

Jewelry, estimated worth. 250.00 

Cash in House. 75.00 

Cash in Bank. 1,210.00 


Saddle Horse and Equio- 
ment, estimated worth. 395.00 


$5,560.00 


Due for Rent—K. Ostengo.$200.00 
Due for Groceries—J. Al¬ 


brecht . 50.00 

Due for Meat—P. Sohmer. 25.00 
Due for Wearing Apparel 

—S. Trotter. 75-00 

Due to Clubs, for Mem¬ 
bership . 80.00 

Due to Housekeeper, wages 

1 month. 50.00 

Due to Valet, wages 1 

month. 50.00 

Due to City Stables, keep 
of Saddle Horse. 65.50 


$595 50 , 


John Doe discounted in June, 1916, $4,000 of notes 
due August, 1916, and indorsed two notes of B. Burns, 
amounting collectively to $800, due September, 1916. 

Required: 

Summary of debts and assets to be submitted to the 
Court, made in accordance with requirements pre¬ 
vailing in such cases. 


PROBLEM XXX 

To introduce the theory of the accounts of executors. 
(See Chapter XLI.) 
























PRACTICAL PROBLEMS 


573 


M. T. Fordham s will named A. Abner as his executor. 
Fordham died May i, 1916; his will was duly probated, and 
on May 10, 1916, the Court issued to A. Abner letters 
testamentary. Prior to the receipt of said letters, Abner 
paid $475 for the funeral expenses of the deceased. 

Soon after qualifying as executor, Abner filed with the 
Surrogate of the County of New York the following in¬ 
ventory of the assets, established as of May 10, 1916: 

1st Mortgage, 6 %, due July 10, 1916, on Land and Building of 


S. Turner, which is located at 181st St., Bronx.$5,000.00 

Interest accrued thereon. 250.00 

Note Receivable, J. Simpson, dated March 26, 1916, due 

May 25, 1916, bearing interest, indorsed by J. Spruce. 1,100.00 

Cash in U. S. Mortgage & Trust Company. 500.00 

Cash in Dime Savings Bank. 110.20 

Insurance Policy, New York Life Insurance Company (pay¬ 
able to estate). 1,000.00 

Salary due M. T. Fordham by Browner & Simplex. 350.00 

50 shares of capital stock of the Bacillac Company, par $100 

(worth par). 5,000.00 

Personal Wearing Apparel and Jewelry (appraised). 300.00 


Total.$13,610.20 


The debts amounted to: 

Due for Rent of Apartment.$80.00 

Due to T. B. Roe, M.D. 210.00 

Due to Universal Pharmacy. 3 i- 5 ° 

Due to Miss Spence, trained nurse. 150.00 


Total...$ 471-50 


The expenses incident to the death and burial of the 
testator were: 


Funeral Expenses.$475-°o 

Legal Expenses in connection with Probate, etc. 150.00 

Total.$625.00 


























574 


PRACTICAL PROBLEMS 


The will provides as follows: 


Legacy* to Miss Anna Fordham, sister of testator.$3,000.00 

Legacy to Mrs. Mary Fordham, mother of testator. 6,000.00 


Remainder of the estate to go to George and Ruth Tesley, the 

testator’s nephew and niece. 

The expenses of the executor amounted to $60.40. Dur¬ 
ing the month of June, the Bacillac Company declared and 
paid a dividend of 6% per share. The executor collected 
$32.40 interest on bank balances, and sold the stock of the 
Bacillac Company at $102, paying no commission on the 
sale, which was to a private party, and incurring no ex¬ 
penses thereunder. The mortgage was paid at maturity, 
with interest. 

Having collected and paid all assets and debts, as per 
above, the executor distributed the legacies in accordance 
with the will, and rendered his accounting to the Surrogate’s 
Court. 

Required: 

1. The schedules required in the final accounting to the 

Surrogate's Court. 

2. The summary statement required in such cases. 


PROBLEM XXXI 

Based on the theory of the account of executors. From 
the New York C. P. A. Examination of January, 1903. 
(See Chapter XLI.) 

By the will of Plenry Palmer, deceased, specific bequests 
were made to three of his children, viz.: William, $100,000; 
Mary, $75,000; and Emma, $75,000. A sum of $20,000 





PRACTICAL PROBLEMS 


575 


was bequeathed to charitable institutions, and his eldest son, 
Henry, was named as residuary legatee. In accordance with 
the terms of the will all real estate was sold, the amount 
realized being $75,000. The inventory hied by John Jacobs, 
executor, was as follows: bonds and stocks, $87,500; bonds 
secured by mortgages, $135,000; furniture and other house¬ 
hold effects, $2,750; cash in bank, $1,237.50. 

On an accounting the executor’s books showed dis¬ 
bursements as follows: undertaker’s bill and other funeral 
expenses, $675; probate of will, legal expenses, publishing 
citations, etc., $14,278.75; debts of testator, $10,875.25; 
stationery, postage, etc., $118.75; improvements on real 
estate, $750.50; repairs on real estate, $4,860.75; taxes and 
insurance, $17,505; care of cemetery plot, $350; services of 
accountant, $1,800; cost of executor’s bond, $1,400. 

Receipts were as follows: sale of bonds and stocks, 
$86,327; bonds and mortgages paid, $98,915; sale of furni¬ 
ture, etc., $2,285.75; interest on bonds and mortgages, 
$61,270.50; interest on deposits with trust companies, 
$1,275.45; rents, $17,250; dividends on bonds and stocks, 

$ 37 > 9 i 8 - 5 °- 

The inventory at the date of accounting showed bonds 
and stocks, $18,755; bonds and mortgages, $30,375; and 
cash in accordance with the foregoing transactions, in¬ 
cluding satisfaction of the specific bequests of the will. 

Prepare, with due distinction as to principal and in¬ 
come, a summary statement of the executor’s account, show¬ 
ing the amount of the executor’s commission and the 
amount due the residuary legatee. 



































